America’s Socialism for the Rich

With all the talk of “green shoots” of economic recovery, America’s banks are pushing back on efforts to regulate them. While politicians talk about their commitment to regulatory reform to prevent a recurrence of the crisis, this is one area where the devil really is in the details – and the banks will muster what muscle they have left to ensure that they have ample room to continue as they have in the past.

The old system worked well for the bankers (if not for their shareholders), so why should they embrace change? Indeed, the efforts to rescue them devoted so little thought to the kind of post-crisis financial system we want that we will end up with a banking system that is less competitive, with the large banks that were too big too fail even larger.

It has long been recognized that those America’s banks that are too big to fail are also too big to be managed. That is one reason that the performance of several of them has been so dismal. Because government provides deposit insurance, it plays a large role in restructuring (unlike other sectors).  Normally, when a bank fails, the government engineers a financial restructuring; if it has to put in money, it, of course, gains a stake in the future. Officials know that if they wait too long, zombie or near zombie banks – with little or no net worth, but treated as if they were viable institutions – are likely to “gamble on resurrection.” If they take big bets and win, they walk away with the proceeds; if they fail, the government picks up the tab.

This is not just theory; it is a lesson we learned, at great expense, during the Savings & Loan crisis of the 1980’s. When the ATM machine says, “insufficient funds,” the government doesn’t want this to mean that the bank, rather than your account, is out of money, so it intervenes before the till is empty. In a financial restructuring, shareholders typically get wiped out, and bondholders become the new shareholders. Sometimes, the government must provide additional funds; sometimes it looks for a new investor to take over the failed bank.