Friday, January 22, 2010

Not too big to fail

It had to come. The backlash against the banks was long overdue after the mayhem of the financial crisis of last year. It took the Massachusetts election result, where Ted Kennedy’s seat was won by a Republican (yes the liberal bastion of the US actually voted Republican) to trigger it.

This blogger is a staunch and unabashed votary of free trade, capitalism and the efficiency of markets. This post, which might seem to back a populist move is actually championing the cause of capitalism, although it might appear at first sight to be arguing against it.

The fundamental problem of the financial crisis was the too big to fail theory. The institutions in trouble were too big to be allowed to go bust. Therefore, however crazy their actions were, they had to be bailed out , primarily by the US government, for the consequences of not doing so would have been worse.

This must not be allowed to be repeated. Nobody should be allowed to become so big that irrespective of whatever they do, they cannot go bust. That goes against the basic tenet of capitalism – sure, capitalism rewards success handsomely, but it equally punishes failures and kills those that deserve to be killed.

For some time there were competing pulls and pressures within the US government on what to do on this issue. Of course the banks clambered over themselves to preach the gospel of capitalism, as the times have started to turn good. No regulation, should allow innovation, scale brings efficiency, should not penalise a company for success, etc etc.

With the Senate filibuster majority now gone, thanks to Massachusetts, the kids gloves have come off. President Obama has proposed two significant measures – restrictions on proprietary trading by the banks and limits on the size and concentration of financial institutions. This post is not to discuss the technicalities of these – no doubt they would be opposed as the wrong way to go about it and there would be fierce lobbying. But directionally they are right. It is now time for the world (read US) to act and make sure there is no institution that becomes too big to fail. Good luck to the banks when they win ; we won’t grudge them their success and good riddance to them when they lose; we won’t shed any tears either.

Tim Geithner the Treasury Secretary put it well . “Just because things seem populist doesn’t mean they’re not the right thing to do”, he said.

As an aside, I think the Massachusetts result is actually a boon for Obama politically , although the Democrats lost. Even in the acrimonious health care debate, which is now prone to Republican filibuster in the Senate. By losing the battle, he may have improved his chances of winning the war.

Maybe, just maybe, they will succeed in abolishing the concept of too big to fail (doubtful, but its not a crime to hope). If that does happen, the world owes a thank you to the people of Massachusetts.