Friday, March 1, 2013

Economist's View: 'How To (Maybe) End Too Big To Fail'

... How To (Maybe) End “Too Big To Fail”
So, how will we deal with the megabanks? Emmons outlined two basic approaches: radical and incremental. The radical approach involves structural changes imposed on the banks themselves or the creation of a different legal definition of what a bank is and what it can do. Radical proposals include:
  • Reduce their complexity and size – Revive the 1933 Glass-Steagall Act (partially repealed by the 1999 Gramm-Leach-Bliley Act) prohibiting combining commercial banking with investment banking or insurance underwriting. Also, reduce their size by placing limits on banks’ assets or deposits. However, Emmons said this proposal likely wouldn’t succeed because combining commercial and investment banking was not the main source of problems; in fact, many of the “too-big-to-fail” institutions that caused problems during the crisis would have been allowed to operate under Glass-Steagall.
  • Create “narrow banks” – Separate payments functions from all other financial activities. Such a bank would take deposits and make payments but not make loans except those that have very little default risk. Emmons said this proposal wouldn’t be successful either because such banks are not likely to be viable. Narrow banks likely would seek to make riskier loans to improve their profitability, while non-narrow banks would seek to enter the payments business in one way or another.
In Aperiomics large banks and corporation need not be a problem, often they give stability to the system because of their size and ability to absorb chaotic shocks. Also being bailed out by the government is a kind of implicit insurance which is how V maintains randomness, people in V government such as Republicans are part of their team. The problem was the IV branches under these V companies, they used deceptive and predatory ways to profit from B workers with subprime. They also competed against each other with too much leverage in derivatives, this is like making trees that are weak in the V leaves because the branches were too long and fragile. Propping up these branches can create zombie banks if they are too large to ever be stable. Large V banks can stifle the growth of smaller banks like trees because of their ability to be bailed out, they can then do more risky business than the smaller banks can because of this risk premium. 

Glass Steagall in effect separated Roy and Biv functions of banks, predatory trading with high leverage is more Oy with Y banks benefiting from this. Often there is no real desire to benefit both parties, just to make the counterparty lose money. Commercial banks however usually benefit both parties as a loan is made and is paid back, when these are combined it can be like putting parasites in to a healthy forest where they use the formerly Biv money to grow even more predatory as well as to loot the wealth of these trees. Often there is a resistance to this process in a tree over time because of evolution, however the sudden repeal of Glass Steagall was more like a desire to loot these healthy Biv banks when they had few defenses against it. 

The problem is weak I-O policing so that fraud and theft are not prosecuted, this is more common in Y and V because they are separated from the I-O police by a layer of Iv-Oy agents that can be deceptive to protect them. Consequently these agents needs to be used as whistle blowers and offered plea bargains to get at Y-V, if not then they continue to side with Y-V until the problems become much larger.

“In fact, we have chosen not to pursue radical approaches to solving the ‘too-big-to-fail’ problem,” he said. “Instead, we’re implementing incremental—albeit significant—reforms of the existing legal, regulatory and governance frameworks in which banks operate.” Meanwhile, bankers, regulators and legislators won’t know whether the regulatory reform efforts will actually work until they are actually used. Those efforts, which have sparked a lot of profound debate throughout the financial industry, include:
  • The 2010 Dodd-Frank Act – The law includes living wills for orderly dissolution, capital requirements, stress tests, risk-based assessments on deposit insurance, FDIC orderly liquidation authority, the Volcker Rule and investor protections. “These are all pushing banks to be more effective in internal discipline,” Emmons said.
  • Basel III Accord – The third round of the Basel Accords is looking to improve the quality of bank capital and make other changes related to capital so that big banks demonstrate that they “have more skin in the game,” Emmons said.

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