The danger of too big to fail (TBTF) banks is well known.
The question remains concerning why do they exist and what can be done about
it. External break-up and capital solutions have failed. They have been
defeated by well financed lobbing efforts. Hope for a market based solution
building on the work of the late Ronald Coase is beginning to take shape.
According to Coase, firms exist because they reduce
transactions costs compared to other forms of activity. There is a limit
regarding what firms can produce internally. Once reached, performance suffers,
and the firm is pressured to refocus to improve returns. For banking that limit
has been reached for the TBTF banks as reflected in their mediocre returns.
These institutions are not only TBTF, but also too big to manage. Evidence is
provided by the almost daily revelation of operating problems and litigation.
By all rights, they should restructure. Inhibiting this
effort is the offsetting funding subsidies TBTF banks receive from the
government. The increasing legal costs of TBTF may be offsetting enough of the
subsidy to encourage a voluntary break-up of the TBTF banks. See my attached
American Banker article on this matter.
J
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