The simple fact is that any regulatory attempt to minimize the impact of failure of a “too big to fail” firm on the financial system will create winners and losers (or favorites) in the marketplace and lessen moral hazard. The purists among us would argue that the whole theory that a “too big to fail” firm failing could bring down the global financial system is highly incredulous and that the best response is for government to step back and allow the market to operate on its own. Should a bank fail and there be a shock to the system, I would argue that the shock may be severe, but it’d also be temporary and have little lasting damage other than to enhance moral hazard and instill discipline in financial institutions that theretofore had lacked it in sufficient quantity.
OTOH, if you accept that financial regulatory “reform” is a fait accompli, there is an easy fix to the problem Indiviglio describes. To the extent that institutions which fall under this new regulatory umbrella gain a market edge on smaller firms outside this umbrella because their creditors can expect to receive more of their money back than in a bankruptcy proceeding, a simple solution would be to tax the firms covered under the umbrella and put that money into an account which pays out when one or more firms fail (similar to how the Pension Benefit Gauranty Corporation operates). Theoretically, the burden of paying this tax (or call it an insurance premium) would be a sufficient hit to A. incentivize firms to stay small enough that they are not covered by this new regulatory umbrella, or B. distort pricing such that smaller firms have a pricing advantage, as creditors end up paying a premium to do business with “too big to fail” institutions. The challenge of the PBGC solution is that there is no guarantee the system would simultaneously 1. tax firms at the correct rate to sufficiently cover a major financial institution failure, and 2. distort market pricing enough to level the playing field between large firms under the umbrella and small firms outside the umbrella.
I think this article misses the point. The people running the firm as well as the shareholders up until it’s taken over lose. So they have an incentive to not allow this to happen. They also have the most influence over this.
RT @TheAtlantic: How #FinReg actually creates “too big to fail” firms: http://ow.ly/2bgzO
The simple fact is that any regulatory attempt to minimize the impact of failure of a “too big to fail” firm on the financial system will create winners and losers (or favorites) in the marketplace and lessen moral hazard. The purists among us would argue that the whole theory that a “too big to fail” firm failing could bring down the global financial system is highly incredulous and that the best response is for government to step back and allow the market to operate on its own. Should a bank fail and there be a shock to the system, I would argue that the shock may be severe, but it’d also be temporary and have little lasting damage other than to enhance moral hazard and instill discipline in financial institutions that theretofore had lacked it in sufficient quantity.
OTOH, if you accept that financial regulatory “reform” is a fait accompli, there is an easy fix to the problem Indiviglio describes. To the extent that institutions which fall under this new regulatory umbrella gain a market edge on smaller firms outside this umbrella because their creditors can expect to receive more of their money back than in a bankruptcy proceeding, a simple solution would be to tax the firms covered under the umbrella and put that money into an account which pays out when one or more firms fail (similar to how the Pension Benefit Gauranty Corporation operates). Theoretically, the burden of paying this tax (or call it an insurance premium) would be a sufficient hit to A. incentivize firms to stay small enough that they are not covered by this new regulatory umbrella, or B. distort pricing such that smaller firms have a pricing advantage, as creditors end up paying a premium to do business with “too big to fail” institutions. The challenge of the PBGC solution is that there is no guarantee the system would simultaneously 1. tax firms at the correct rate to sufficiently cover a major financial institution failure, and 2. distort market pricing enough to level the playing field between large firms under the umbrella and small firms outside the umbrella.
I think this article misses the point. The people running the firm as well as the shareholders up until it’s taken over lose. So they have an incentive to not allow this to happen. They also have the most influence over this.