Counterparties: Small enough to fail?

October 11, 2012

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Too big to fail is a problem that has ostensibly been solved, thanks in part to banks’ “living wills”. But, as Sheila Bair has argued, simply saying that you’re no longer too big too fail does little to remedy the market’s perception of an implicit government backstop.

Daniel Tarullo, the Fed’s expert this thorny issue, has a simple proposal — he wants to limit the amount that banks can borrow from the markets.

In addition to the virtue of simplicity, this approach has the advantage of tying the limitation on growth of financial firms to the growth of the national economy and its capacity to absorb losses, as well as to the extent of a firm’s dependence on funding from sources other than the stable base of deposits.

Of course, the difficult question would be the applicable percentage of GDP. The answer would depend on a judgment as to how much of an impact the economy could absorb. It would also entail a judgment as to how large and complex a firm needs to be in order to achieve significant economies of scale and scope that carry social benefit. Depending on the answers to these questions, there may be a need to balance the relevant costs and benefits… Even good answers to all these questions would produce a policy instrument that could seem excessively blunt to some. But this is a debate well worth having.

Simon Johnson made the same proposal in November 2009, and senators Sherrod Brown and Ted Kaufman even proposed legislation to that effect in 2010. But nothing came of it, and the WSJ’s Victoria McGrane has a great chart detailing where we are now, in terms of non-deposit liabilities as a percentage of GDP. JP Morgan leads the pack with 6.3%, closely trailed by BofA at 5.7%, and Goldman Sachs and Citgroup each at 5.2%.

The FT’s Shahien Nasiripour notes that Tarullo’s proposal comes in addition to the current cap on banks holding no more than 10% of the country’s deposits to more market-based metrics. This makes sense: Tarullo is a long-time critic of the risks posed by the shadow banking system. Capping banks’ exposure to things like the shadow banking system could, the argument goes, make them just small enough to fail. — Ben Walsh

On to today’s links:

Financial Arcana
Searching for profit, banks turn to rainy-day reserves – WSJ

New Normal
Every economic recovery looks exactly the same – and that stinks – Derek Thompson

The Airing of Grievances
The 12-year-old son of a Wall Street trader texts Michael Lewis, complains about his dad – Michael Lewis

Even rating agencies are unimpressed by rating agencies – Matt Levine

Bank of America’s “independent foreclosure review” mostly being done by Bank of America – Paul Kiel

Crisis Retro
The case against JP Morgan and Bear Stearns offers a “facsimile of justice” but little else – Bethany McLean

It’ll help you lose 10 pounds, but “pre-commitment” is a disaster for Congress – James Surowieki

Emails suggest private equity titans are kind to each other (with respect to price-fixing) – Dealbook
Full text: The lawsuit against private equity’s biggest players – Dealbook

Are you on the Internet right now? – Choire Sicha

“Ezra Pound wrote to [Huey] Long in 1935 offering his services as future U.S. Secretary of the Treasury” – Neoamericanist

US borrowers would have saved if loans had not been tied to Libor – Cleveland Fed

Be Afraid
The coming dementia plague – Technology Review

Niche Markets
The supply, demand, and monopolization of in-flight Wi-Fi – BuzzFeed

JP Morgan
JPMorgan’s CFO is stepping down – WSJ

Alternative Currencies
Hobbit coins become legal tender in New Zealand – AFP

Zynga’s stock falls below the value of its cash and real estate – LAT

Goldman’s employee email search turns up 4,000 mentions of the word “Muppet” – FT



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