Counterparties: Small enough to fail?
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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: