Wednesday, 11 January 2012

Everybody join in the Too-big-to-fail bandwagon!

According to a recent article published by Bloomberg, global regulators (whoever they may be) from the Financial Stability Board met in Basel, Switzerland to decide on a "framework for domestically systemically important banks" which should be up and going by next year. This would expand the list of financial institutions which, in case of failure, would pose risks to the stability of the domestic system, and therefore should be regulated. After we saw insurers (AIG) and  governmental mortgage associations (Fannie Mae, Freddie Mac) being bailed out in 2008, it is time to also regulate the so called shadow banks.


The real question here is if companies should be allowed to get to the point where there failure could send systemic ripples throughout the entire system. I believe that, while there may be arguments in favor of huge size financial companies (advantages of scale, operational efficiency, robustness, possibly lower commissions and fees), there are a bad trade-off, compared to their use of monopolistic techniques. Moreover the argument of being to big to fail signals a failure of the free competition of the market. If there were a perfect market the clients would have perceived the risks and moved to a smaller, safer financial institution.

The shadow banking sector

Most likely  the type of financial institutions to be included in this too-big-to-fail list are the so-called shadow banks: financial companies that issue credits (through one way or the other) from internal funds: money market mutual funds, special investment vehicles, governmental mortgage insurers and hedge funds that supply credit, clearing houses (the impact of the failure of MF Global should serve as an early warning sign that things may get worse) and some types of insurers. These institutions will be looked into by the European Unions financial services commissioner, Michael Barnier, and "go as fast as he can" in considering special regulation.

Is this really necessary ?

The so called hot money is hotter and hotter now with ever-increasing speeds of clearing orders. This means that financial flows can change directions and respond to cripples in a very quick way (especially if they are controlled by computer algorithms). Therefore a small shock (say the failure of a domestic bank) could compound in a matter of days and pose threats to the whole financial system. Regulation for avoiding these situations (preferably not by governmental bail-out using taxpayer's money) is imperative, to say at least. The other side of the coin is that, financial companies should not be allowed to grow to the point where they threat the stability of the entire market (near monopolies always end up in flames).

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