Click Here To Read Too Big To Live: Joseph Stiglitz
Introduction (Via Project Syndicate)
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.
Favorite Excerpts (Via Project Syndicate)
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.
· Financial institutions are too intertwined to fail; the part of AIG that cost America’s taxpayers $180 billion was relatively small.
· Even if individual banks are small, if they engage in correlated behavior – using the same models – their behavior can fuel systemic risk;
· Incentive structures within banks are designed to encourage short-sighted behavior and excessive risk taking.
· In assessing their own risk, banks do not look at the externalities that they (or their failure) would impose on others, which is one reason why we need regulation in the first place.
· Banks have done a bad job in risk assessment – the models they were using were deeply flawed.
· Investors, seemingly even less informed about the risk of excessive leverage than banks, put enormous pressure on banks to undertake excessive risk.
· Regulators, who are supposed to understand all of this and prevent actions that spur systemic risk, failed. They, too, used flawed models and had flawed incentives; too many didn’t understand the role of regulation; and too many became “captured” by those they were supposed to be regulating.
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