Banks too big to fail, or to exist?

Nouriel Roubini is professor of economics at the Stern School of Business, New York University and chairman of RGE Monitor, an impressive think tank and economic observatory. Both in an article in the Financial Times and in the weekly newsletter of RGE, he comes back to the very worrying situation created by banks that may appear as being too big to fail, when common sense would suggest that any private company that would be considered as too big to fail would in fact be in a position of blackmailing all taxpayers in the country.

Here some excerpts :

"The securitisation and structured finance market is moribund – for now. It will not be resurrected, without public subsidies, unless much greater transparency, liquidity and standardisation is introduced. The roles of New York and London as major financial centres are being reduced as the financial crisis reveals the weakness of the Anglo-Saxon model of lightly regulated finance. Over time, alternative financial centres, both traditional (Tokyo, Singapore, Hong Kong) and new (Dubai, Shanghai, Mumbai, São Paulo, Moscow) will emerge as the Bric countries (Brazil, Russia, India and China) and other emerging markets (especially in the oil-exporting Gulf) increase their share of global GDP.

We must also deal with the “too-big-to-fail” institutions, an issue that has actually been exacerbated by government bail-outs. As well as causing even greater moral hazard, the bail-outs have led to the consolidation of financial institutions into even larger financial behemoths – which still need to be broken up. A new bankruptcy regime that allows the orderly wind-down of important financial institutions needs to be legislated. Such institutions should have higher capital requirements than smaller ones and their activities should be supervised and regulated on an international basis.

But the true solution to the too-big-to-fail problem requires more radical choices. In addition to an insolvency regime, such institutions should be broken up and unsecured creditors of insolvent institutions should have their claim automatically converted into equity. A separation of commercial banking and risky investment banking should also be considered. Thus, some variant of the Glass-Steagall Act should be reintroduced.

As markets begin to mend and financial institutions return to profitability, the drive to reform the regulation of the financial system is losing political momentum. There is now a serious danger that risky practices and leverage could return.

If another systemic crisis were to occur, the backlash against global finance and the free market would be even more severe. To prevent another asset bubble from building into a financial crisis, reform must be implemented with haste.

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