The issue of TBTF — or too big to fail — is at the crux of our recent recession. The recession threatened our financial system and led to government help for many bank and financial institutions, but critics say the expectation of this government backstop motivated many in the financial sector to take big risks and this behavior contributed to the recession in the first place. Is there an easy way to resolve this issue? N.C. State University economist Mike Walden answers.
“Well, number one … we do have some new federal legislation that was passed two years ago that has a goal of spotting trouble in financial institutions early and taking action to head it off so that the federal government does not have to come in and bail out financial institutions. There (are) disagreements among economists as to whether indeed this will work and certainly we’ll have to see over time as that this new law gets applied.
“There (is) another group of economists that say, ‘Hey, the answer to this is simply to try to move, particularly financial institutions that are very large, chop ’em up. Make ’em smaller.’ That is so that we don’t have a lot of big banks — that we have many, many smaller banks.
“And indeed what we see, if you look at the data, is there has become more concentration in financial institutions. Now there’s a rhetoric to that. Other economists say, ‘Well, if you do that, if you pass a law that says, well, a bank in the U.S. can’t be only so big, what’ll happen is that many people who do banking business and they want to do business with a big bank will simply go offsite. They’ll go offshore. They’ll go to European banks or Asian banks.
“A final solution may be to simply say — the government say – ‘Hey, big bank, if you get in trouble, we’re not going to help you.’ Probably, however, for that threat, if you will, to be taken seriously, we would have to go through a recession, and we’d have to see the government actually follow through on its threat not to help. And, of course, that would mean we’d have to go through some financial pain.
“So, this is a big, big issue. There’s not a real clear answer. But it’s certainly an issue that we’re going to continue to have to deal with in future economic down turns.”
Category: Economic Perspective