Tuesday, February 17, 2009

The Too-Big-To-Fail Doctrine

From Free Market Myth by Dean Baker:

In the context of a too-big-to-fail principle, the removal of restrictions on leverage (investment banks were allowed to leverage their capital at a ratio of forty-to-one compared to just ten-to-one for commercial banks) and the relaxation of other prudential regulation (the nominal value of credit default swaps, a new class of derivative instruments, grew to more than $70 trillion in a nearly unregulated market) essentially gave the banks a license to wager with taxpayers’ money.

Banks did exactly what economic theory predicts. They took huge risks, leveraging themselves to the hilt with questionable assets, knowing that they would gain as long as the housing bubble held up. And the banks did so with willing accomplices among pension funds, hedge funds, and other investors because these investors knew that the government would rescue them if things went badly.

Deregulation can be a principled position held by true believers in a free market. But Wall Streeters all wanted one-sided regulation that provided them with an enormous government security blanket without any costs or conditions. None of the Citigroup, Goldman Sachs, J.P. Morgan crew ever went to lobby Congress for an explicit repeal of the too-big-to-fail doctrine. And while many on Wall Street lost their jobs when the bubble burst, the tens or hundreds of millions of dollars that banking executives earned during the good times are theirs to keep. Even with the market collapse, the vast majority of them are almost certainly better off than they would have been had they done honest work over the last decade.

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