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Too Big to Live

NEW YORK – A global controversy is raging: what new regulations are required to restore confidence in the financial system and ensure that a new crisis does not erupt a few years down the line. Mervyn King, the governor of the Bank of England, has called for restrictions on the kinds of activities in which mega-banks can engage. British Prime Minister Gordon Brown begs to differ: after all, the first British bank to fall – at a cost of some $50 billion – was Northern Rock, which was engaged in the “plain vanilla” business of mortgage lending.

The implication of Brown’s observation is that such restrictions will not ensure that there is not another crisis; but King is right to demand that banks that are too big to fail be reined in. In the United States, the United Kingdom, and elsewhere, large banks have been responsible for the bulk of the cost to taxpayers. America has let 106 smaller banks go bankrupt this year alone.  It’s the mega-banks that present the mega-costs.

The crisis is a result of at least eight distinct but related failures:

·        Too-big-to-fail banks have perverse incentives; if they gamble and win, they walk off with the proceeds; if they fail, taxpayers pick up the tab.