Statement Concerning Too Big To Fail (TBTF)

I found the Opening Statement at the Full Committee Hearing on 'Too-Big-to-Fail' Post- Dodd-Frank, made yesterday (June 26) by The Committee On Financial Services' Chairman Hensarling, to be notable.

While I don't necessarily agree with everything said in this Opening Statement - or with all aspects of the following excerpts - here are the excerpts I found most notable:

Today, though, there is a growing bipartisan consensus that the Dodd-Frank Act regrettably did not end the Too Big To Fail phenomenon or its consequent bailouts.

also:

Ending taxpayer funded bailouts is one of the reasons why this committee has invested so much time on Sustainable Housing Reform. The GSEs, Fannie and Freddie, are the original Too Big to Fail poster children, yet were untouched and unreformed in Dodd-Frank. They have received the largest taxpayer bailout ever - nearly $200 billion. Along with the FHA, the government now controls more than 90% of our nation’s mortgage finance market with no end in sight.

also:

Regrettably, Dodd-Frank not only fails to end Too Big to Fail and its attendant taxpayer bailouts – it actually codifies them into law. Title I, Section 113 allows the federal government to actually designate Too Big to Fail firms – also known as SIFIs. In turn, Title II, Section 210, notwithstanding its expost funding language, clearly creates a taxpayer funded bailout system that the CBO estimates will cost taxpayers over $20 billion.
Designating any firm Too Big to Fail is bad policy and worse economics. It causes the erosion of market discipline and risks further bailouts paid in full by hardworking Americans. It also becomes a self-fulfilling prophecy, helping make firms bigger and riskier than they otherwise would be. Since the passage of Dodd-Frank, the big financial institutions have gotten bigger, the small financial institutions have become fewer, the taxpayer has become poorer, and credit allocation has become more political.

my comment:

I’ve previously discussed “Too Big To Fail” and “Moral Hazard” in numerous posts.

I continue to believe that Too Big To Fail (TBTF) and Moral Hazard issues are of paramount importance.  Regrettably, my analyses indicate that the issues lack both recognition and effective remedy.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 1613.93 as this post is written

Fairness Of The U.S. Economic System

On January 25, Gallup published poll results in a release titled "Americans Divided on Whether U.S. Economic System Is Unfair."

In the poll results, it is seen that 45% think the economic system is "fair" while 49% think it is "unfair," with 6% having "no opinion."

The poll also asks "Do you think the U.S. economic system is fair or unfair to you, personally?"

This issue of whether the economic system is "fair" is very important.  I believe that "fairness" of an economic system - especially that of one considered "capitalist" in nature - is a very complex issue.

While I have many thoughts on the issue, I will defer commenting on the issue of fairness of the economic system primarily because my comments would be exceedingly lengthy and complex.

However, for now, I will say that any discussion of fairness would include the concept of Moral Hazard, which I have previously commented upon.

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The Special Note summarizes my overall thoughts about our economic situation

SPX at 1342.57 as this post is written

Stiglitz Interview - Notable Excerpt

Today's Barron's has an interview with Joseph Stiglitz.  I found his answer to the following question to be an interesting perspective:

Before we talk about all that, what are the most surprising developments since you won your Nobel Prize?

Surprising to whom? The bubble episode surprised so much of the world—Greenspan and Bernanke believed that markets knew how to handle risk, self-regulation was adequate and the banks had incentives to manage risk and so forth and so on. We saw that it isn't true—in a very dramatic way. That wasn't surprising to me because my Nobel Prize was about the economics of information and this notion of agency theory, that the people who are making decisions do not necessarily reflect the interests of those who they are supposed to be serving.

The kind of incentive schemes that were being employed by firms, banks and financial institutions weren't consistent with any model of rational behavior other than exploitation. If you believe incentives matter, something untoward was going to happen. At the level of markets, securitization had some fundamental flaws, because you didn't have the incentives to monitor or manage them and created a moral hazard. To our leaders and erstwhile gurus, it came as a very big surprise. You have a market economy where incentives do matter, but in which they aren't always aligned.

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The Special Note summarizes my overall thoughts on our economic situation

SPX at 1273.72 as this post is written

Larry Kudlow Comment On January 13 Regarding "Too Big To Fail"

On Thursday, Larry Kudlow interviewed Rep. Spencer Bachus on CNBC.

I found one comment Kudlow made, starting at the 6:17 mark,  to be especially notable:

"Many people believe that the top 5,6,8 banks are in fact too big to fail and constitute government sponsored enterprises in effect.  That is an unfair advantage in the credit markets that is sort of like Fannie and Freddie all over again...you know private profit but public taxpayer risk...."

My comment:

As time goes on, the issues of "Too Big To Fail" and "Moral Hazard" are being discussed less and less, which is unfortunate.  There are many aspects of each of these concepts that are profoundly important to our economic system.

I've previously discussed "Too Big To Fail" and "Moral Hazard" in numerous posts...

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A Special Note concerning our economic situation is found here
SPX at 1293.24 as this post is written

"Too Big To Fail"

The term "Too Big To Fail" is heard frequently.

However, for all of the talk regarding its danger, very little if anything has been done to rectify the condition.

As seen in The Wall Street Journal of December 16, p C18, "The top four banks have combined assets of $7.4 trillion, or 56% of the U.S. banking sector's total. In 2000, the top four's $2 trillion of assets accounted for 35% of the total."

"Too Big To Fail" has many adverse consequences. Perhaps the most serious is that it potentially fuels moral hazard.



SPX at 1102.47 as this post is written

Moral Hazard Speech

Here is a link to an October 20 speech given by Mervyn King. The speech speaks of the concept of Moral Hazard:

http://www.bankofengland.co.uk/publications/speeches/2009/speech406.pdf

Although there are various notable passages, I found this line perhaps most interesting:

"The massive support extended to the banking sector around the world, while necessary to avert economic disaster, has created possibly the biggest moral hazard in history."

I have commented on Moral Hazard previously on this blog. As I have noted, there has been very little (especially relative to the size of the issue) commentary or attention given to the issue. I believe the Moral Hazard issue is of the greatest importance.

Moral hazard should have been addressed via credible policy many years ago. I am certain that by neglecting this issue we will see immense damage.



SPX at 1098.22 as this post is written

Bank Bonuses and Broader Implications

I'd like to make a brief comment about the "bank bonus" story that came out a few days ago. Here is one article on it, titled "Bank Bonus Tab: $33 Billion" from The Wall Street Journal on 7-31-09:

http://online.wsj.com/article/SB124896891815094085.html#articleTabs%3Darticle

Needless to say, it seems outrageous that such bonuses, in said amounts, were paid out so broadly in 2008 given the overall situation - especially for those banks that would have otherwise collapsed absent tremendous levels of government intervention. Of course, there may be some mitigating factors or legitimate reasons for at least some of these bonuses, but I have yet to read or hear of any.

It seems as if this bonus issue should have been adequately addressed before any intervention funds were allotted to the various banks.

Overall, I think the two major issues concerning these bonuses are Fairness, as well as the impact on Moral Hazard.

As I have alluded to previously (on a 6/21/09 post) the Moral Hazard environment that has been created and perpetuated over the last few years is truly epic and mind-boggling. It appears as if this Moral Hazard situation has only been exacerbated with the Bank Bailouts that have occurred during The Financial Crisis.

Moral Hazard implications are very important, even if (seemingly) few people really want to think about them. Moral Hazard has many types of direct and indirect effects ranging from our potential National Debt to issues regarding Sustainable Prosperity to issues concerning Fiduciary Responsibility. Part of the challenge, and importance, of crafting appropriate national policy is to consider, in totality, how the economic environment will be impacted by various government actions. To ignore, or downplay, Moral Hazard implications is a serious mistake.

SPX at 1002.63 as this post is written

Financial Terms That Have Fallen Out of Use

I find it interesting that certain financial and economic terms seem to have completely fallen out of use, especially in the press.

Among these I would include "Quality of Earnings" and "Fiduciary Responsibility."

As well, "Moral Hazard" is still used but surprisingly much less than one would think. It seems to be on the way out.

What is the significance of these terms falling out of use?

I'm sure there are many other financial and economic terms that have fallen out of use. Let me know of any others that come to mind...

SPX at 940.49 as this post is written


Copyright 2009 by Ted Kavadas

Moral Hazard Wonderland

Moral Hazard Wonderland
Sunday, June 21st, 2009

To date, I haven’t written or otherwise commented about the issue of Moral Hazard.

Perhaps the main reason is that I am afraid if I start writing about it, I may never stop…

Needless to say, the issue of Moral Hazard and its implications are massive, and just seems to grow with time. It seems as if the issue has taken a “back seat” for quite a while now, and, paradoxically, seems to have become even less of an issue, policy-wise, since The Financial / Economic Crisis began.

The following is an interview with FDIC Chair Sheila Bair which discusses the Moral Hazard topic and related issues:

http://www.cnbc.com/id/31443313

SPX at 921.23 as this post is written