Thursday, 31 July 2014

TBTF for beginners.

One way of disposing of the Too Big To Fail problem is obviously to break up “big” banks. But that might involve forgoing economies of scale. So assuming we decide to keep those economies of scale, that means TBTF banks will stay in place.
And that in turn means that in order not to give big banks any sort of edge on smaller banks, ALL BANKS have to be made so safe that failure is impossible. But that clashes with the very reasonable idea that any business in a free market should be allowed to fail. So what’s the escape from that dilemma? Well it’s easy.
All banks or “lending entities” can be made fail safe in the sense of making it impossible for them to go insolvent: that can be done by having them be funded just by shareholders and not by depositors, bondholders or similar. That rules out insolvency, though it doesn’t prevent a serious decline in the value of bank shares and a takeover given incompetent management .
So that solves the problem, unless I’ve missed something. That is, the TBTF subsidy vanishes while we still get the economies of scale that big banks confer on us.
Oh by the way, the latter system is called “Full Reserve Banking”.

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