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"Too Big to Fail" – Missing a Global Perspective?

Tue, Apr 21 2009, 22:30 GMT
by Northern Trust Economic Research Department

Northern Trust

“Too Big to Fail” – Missing a Global Perspective?

Today, President Hoenig of the Federal Reserve Bank of Kansas, Prof. Stiglitz of Columbia University, and Prof. Johnson of MIT presented their opinions and solutions about how to prevent a systemic threat from large financial institutions at the Joint Economic Committee (Too Big to Fail or Too Big to Save? Examining the Systemic Threats of Large Financial Institutions).

President Hoenig is of the opinion that “failure” is an option. He presented a detailed resolution framework “such that market participants can rely on when determining their strategies and making their decisions.” He also stressed that “regardless of the size, complexity or location, the resolution process must provide consistent treatment of a failing institution’s owners, managers, employees, and customers. The process should be transparent and clearly stated so that everyone understands what to expect if they gamble with the firm’s assets.” The need to have to a resolution process is crucial and President Hoenig’s suggested framework is timely.

These are all valuable insights for tackling the crisis and developing an improved framework to operate in. However, there is a missing element here. The Reuters story (FACTBOX: U.S. banks' market capitalization shrinks | U.S. | Reuters) lists the world’s largest banks excluding the Chinese banks. In the text of the news report, it is noted that three out of the top four banks in the world by market capitalization are Chinese banks. Effectively, only three U.S. banks are in this list of the top 13 banks of the world when the Chinese banks are included (JP Morgan Chase, Wells Fargo, and Bank of America). In this global set up, Professor Johnson suggests that “you need to force the new equity owners of banks to break them up, so they are no longer too big to fail – making it harder for the new oligarchs to blackmail the government down the road.” Prof. Stiglitz considers it necessary to break up the institutions and regulating them heavily to prevent another economic crisis. His analysis is important and useful in many respects but it misses the global context of financial institutions. I confess I have not followed the Q & A of these testimonies. On quick reading of these testimonies, it appeared these questions need to be addressed. In the event that large banks are broken up, how will they compete in a global economy? Will U.S. laws prevent the operations of foreign financial institutions in the U.S. because they are too big to operate in the U.S.? Hypothetically speaking, if large U.S. financial institutions are split into smaller banks, a failure of a large foreign bank, which has ties with several small U.S. banks, could result in a financial calamity. The FDIC will be conducting rescue operations in this scenario also. Therefore, a regulatory framework for financial institutions in a global context is the appropriate topic for discussion. It appears that transparency, accounting standards, and a global regulatory framework matter far more than the size of institutions.

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Published on  Tue, Apr 21 2009, 22:33 GMT