Wednesday, June 30, 2010

Financial Reform Legislation Does Not Eliminate Too Big To Fail


Gee, this is a big surprise.
clipped from moneywatch.bnet.com

This bill is not going to end the problem of too big to fail. If the banking system is threatened, then one way or the other it will be bailed out. The consequences to the economy would be too large to do otherwise. Thus, banks that are big enough to pose a systemic risk enjoy an advantage over other banks. Banks that pose a systemic risk will be assumed to be safer than other banks due to the implicit government guarantee. This gives large banks an advantage over smaller banks that do not, on their own, threaten the financial system if they fail.

In addition, the implicit guarantee gives large banks the incentive to take on too much risk, and this is a reason to regulate the amount of risk they can take (and I don’t think the proposed legislation does enough in this regard).

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