The only real solution to Too Big To Fail

In a recent post I suggested that higher capital requirements might be called for if policymakers were unwilling to bite the bullet and remove moral hazard from our financial system.

The FT has a new article discussing a Treasury proposal to end Too Big To Fail, by setting up a new type of bankruptcy for big banks.  I wish them well, but remain skeptical.  In my view, the only way we’ll ever be able to remove moral hazard is with monetary policy reform.  If we can get to a policy of NGDPLT, then policymakers will no longer have to worry about the consequences of the failure of a big bank.  Unfortunately, that’s likely to take many decades, as we first need to implement the policy, and then see how it does during a period of financial distress.  Only then would policymakers begin to feel comfortable rolling back TBTF.  (And even then, special interest groups will try to keep it in place.)

PS.  The NYT has a new post showing that historians view Trump as being the worst President in American history.  That’s also my view.  Some people judge presidential performance by how the country is doing.  That’s about like judging my blogging based on how monetary policy is doing.  A couple posts I’d recommend are Yuval Levin explaining why Trump is not actually the President, in the conventional sense of the term.  He’s not qualified to be President, so day-to-day decisions are made by others.  Thus the GOP “deep state” wisely vetoed his recent attempt at crony capitalism, which would have re-regulated the coal and nuclear industry as a backdoor way of bailing them out.  The outcome was good, but Trump’s specific input into the process was destructive.  Matt Yglesias also has a good post, explaining why Trump is much more corrupt that even lots of left-of-center reporters assume.

PPS.  I have a new post on budget and trade deficits, over at Econlog.



22 Responses to “The only real solution to Too Big To Fail”

  1. Gravatar of Brett Brett
    21. February 2018 at 13:57

    They need to deliberately tie their hands on TBTF. Make it so that bailing out a bank requires a congressional vote, and isn’t just at the discretion of a Treasury official. It could still happen, but at least there’s more of a barrier to it (sort of like requiring those city-subsidized sports stadiums to be submitted to public referendum before the funding is granting).

  2. Gravatar of Joe Joe
    21. February 2018 at 14:05

    anyone done the math on a sustainted budget deficit leading to a leveling off of the debt levels? Not sure I was doing the math right, but in general i get something like the below graph:

  3. Gravatar of Steve Steve
    21. February 2018 at 16:10

    “Trump as being the worst President in American history. That’s also my view.”

    Make Buchanan Great Again!

    It’s seriously amazing how many people have become hard unfollows thanks to Trump Derangement.

  4. Gravatar of Benjamin Cole Benjamin Cole
    21. February 2018 at 16:28

    Trump the worst President?

    Well maybe, but do not forget LBJ who entered the US into Vietnam, where 50,000 US soldiers and a couple million SE Asians died, in a counter-productive effort.

    Nixon left behind 270 million cluster bombs in Laos, 80 million undetonated, causing grievous carnage ever since. Nixon also extended the war past the 1972 elections, knowing the war was lost but wanting to avoid losing before the election.

    George Bush jr, responded to the 9/11 terrorist attack by Saudi Arabians by the counterproductive and fantastically expensive occupations of two entire nations, from which the US cannot seem to extricate itself yet. US life losses in the thousands, loss of natives unknown, possibly in millions.

    Cost of Vietnam, Iraq and Afghanistan probably above $10 trillion (long tails due to the VA). We did create an Islamic-narco state in Afghanistan.

    Trump has a mountain to climb if he wants to be the worst President. Let us hope he tires out in the foothills.

    Anyway, from what I read, all is forgiven on Trump. He cut the corporate tax rate!

  5. Gravatar of msgkings msgkings
    21. February 2018 at 16:55

    @Ben Cole: LBJ didn’t get us into Vietnam, JFK did. LBJ did escalate.

    Nixon wasn’t great, nor W, but they were far from the worst ever. Those are generally agreed to be (in some order) Andrew Johnson, James Buchanan, and Warren Harding

    Honestly it’s too soon to say with Trump. He’s definitely the least qualified, least appropriate president ever, but so far he hasn’t done much that bad. What’s bad about him is mostly about who he is, not what he’s ‘done’.

    This is a good link:

  6. Gravatar of Philo Philo
    21. February 2018 at 17:13

    Levin writes that “we should be careful not to get used to the unacceptable”; he means that we should not get accustomed to Trump. This is idle chatter. We are likely to be stuck with Trump for almost three more years; we may as well get used to him. And is he “unacceptable”? I have accepted him, as I accept other ills that I have no practicable means of remedying. Accepting something doesn’t mean judging it to be good.

  7. Gravatar of Matthias Görgens Matthias Görgens
    21. February 2018 at 20:27

    According to the Econlog thing on Presidential Greatness, Washington and Lincoln were pretty bad. Especially Lincoln was supremely incompetent in waging the war he provoked.

  8. Gravatar of ssumner ssumner
    21. February 2018 at 22:12

    Matthias, Washington was my favorite President.

  9. Gravatar of B Cole B Cole
    21. February 2018 at 23:44


    Good points about some past duds.

    I would say LBJ entered us into Vietnam as our exposure under JFK was rather minute and there is evidence Kennedy regarded as a limited venture, both in scale and time.

    Sheesh, on Nixon I did not even mention Watergate.

    What in infernal perma-wars did Harding ever get us into?

    Trump, in the right time and place, could become the worst president ever, but he has a small playing field today. He is a victim of his time and place.

  10. Gravatar of Benjamin Cole Benjamin Cole
    22. February 2018 at 06:10

    A Shinzo Abe adviser is advocating the Bank of Japan buy foreign bonds.

    So, let us say the Bank of Japan prints (digitizes) $2 trillion and buys US bonds over the next four years.

    The BoJ sends the interest earned to the national government, and the national government cuts taxes by an equal amount.

    Japan actually wants a cheaper yen anyway. And who doesn’t like lower taxes?

    Eventually the bonds mature, and Japan gets a boatload of dollars, which it uses to cut taxes for a several-year period.

    Maybe there are no free lunches, but I think one can obtain discounts…..

  11. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    22. February 2018 at 08:49

    I’ll take seriously anyone who wants to end TBTF if they admit that the problem we encountered in 2008 never would have happened if we’d left the banks alone to decide to whom to lend, in the first place. I.e., we’d never had the Boston Fed publishing either the Munnell piece or ‘Closing the Gap.’

    I see the BosFed has finally scrubbed this pamphlet from their website.

  12. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    22. February 2018 at 09:11

    Here’s one description of Closing the Gap;

    In 1993 President Bill Clinton made changes to the Community Reinvestment Act to make mortgages more obtainable for lower and lower-middle-class families. In 1993 the Federal Bank of Boston issued a report entitled “Closing the Gap: A Guide to Equal Opportunity Lending.” The 30 page document was intended to serve as a guide to loan officers to help curb discriminatory lending [10]

    “Closing the Gap,” instructs banks to hire based upon diversity needs, sweeten the compensation structure for working with lower income applicants, encourages shifting high risk, low income applications to the sub prime market, by saying “the secondary market [Subprime Market] is willing to consider ratios above the standard 28/36,” and “Lack of credit history should not be seen as a negative factor.”

    While, “Closing the Gap” was not an industry-wide mandate, it illustrates the efforts banks took to meet public pressure to overcome mortgage discrimination. Under the Clinton administration community organizers pressured banks to increase their loans to minorities. Karen Wegmann, the head of Wells Fargo’s community development group in 1993 told the New York Times, “The atmosphere now is one of saying yes.” [11] The same New York Times article echoed “Closing the Gap,” writing, “The banks have also modified some standards for credit approval. Many low-income people do not have credit-bureau files because they do not have credit cards. So lenders are accepting records of continuously paid utility bills as evidence of creditworthiness. Similarly, they will accept steady income from several employers instead of the length of time at one job.”

    Because of looser loan restrictions many people who did not qualify for a mortgage before now could own a home.[12] The banks issued loans with teaser rates, knowing that when higher variable rates kicked in later the borrowers would not be able to meet their payments. As long as housing prices kept rising and borrowers could refinance easily, everyone appeared to be doing well.[12]

    Minorities willingly entered sub-prime mortgages in far greater numbers than whites and represented a disproportional percentage of foreclosures….

    Mark well that last line.

  13. Gravatar of Matthew Waters Matthew Waters
    22. February 2018 at 15:17

    I don’t like the CRA, but it didn’t cause the mortgage losses. Mortgage brokers who placed subprime loans and quickly securitized them weren’t under CRA. The brokers didn’t have to be dragged kicking and screaming to make very large profits placing the loans.

    The end buyers of non-conforming MBS were overwhelmingly foreign banks or investment banks. You can blame other, more indirect government action. For example, pension funds, insurance companies and regular banks were the large ultimate funders. PBGC and FDIC would be triggered for pensions and regular banks. Insurers have explicit state level backing. Foreign banks had implicit or explicit backing by their governments.

    Admidst all this government interference, the CRA is often singled out. One can draw their own conclusions about that.

  14. Gravatar of ssumner ssumner
    22. February 2018 at 15:25

    Patrick, You should take those people seriously regardless of how they feel about the CRA, because they are right about TBTF. Indeed neither the CRA or TBTF was the main problem—FDIC was the main problem.

  15. Gravatar of Xavier Xavier
    22. February 2018 at 17:30

    Pretty new to this blog: What does the ‘L’ in NGDPLT stand for?

    I assume it’s Nominal Gross Domestic Product L_____ Targeting?

  16. Gravatar of ssumner ssumner
    22. February 2018 at 18:15

    Xavier, Welcome.

    It refers to level targeting–a promise to come back to the original NGDP trend line, if you temporarily deviate from it.

  17. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. February 2018 at 07:47

    ‘FDIC was the main problem.’

    Except that we had the FDIC for something like 70 years without a banking crisis. And, I submit that if we’d not had the unprecedented interference in the home lending industry, in the 1990s, we’d not have had one in 2008 either.

  18. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. February 2018 at 07:49

    I guess I should have made the above ‘a severe banking crisis’.

  19. Gravatar of Patrick R. Sullivan Patrick R. Sullivan
    23. February 2018 at 07:54

    ‘I don’t like the CRA, but it didn’t cause the mortgage losses. Mortgage brokers who placed subprime loans and quickly securitized them weren’t under CRA.’

    No, they operated under the CRA.’s evil twin, HUD’s Best Practices Initiative. Which was created during the Clinton Admin, by Henry Cisneros.

    Your logic fails because it wasn’t until the 90s that these ‘liar loans’ got made. It wasn’t the bankers’ idea, but the regulators’.

  20. Gravatar of Ralph Musgrave Ralph Musgrave
    23. February 2018 at 12:58

    Why on Earth should NGDPLT make bank failures impossible? Banks fail because they make incompetent loans. NGDPLT may result in the economy working nearer capacity more of the time than inflation targeting, and that would certainly make things easier for banks (and every other type of firm and corporation). But there is absolutely no reason why NGDPLT means an end to incompetence by banks any more than it guarantees an end to incompetence by garages, restaurants, you name it.

    Raising capital requirements reduces the chance of bank failure. As for the line constantly pushed by banks, namely that funding a bank via capital is expensive compared to funding it via debt, that idea was demolished by Messers Modigliani and Miller.

  21. Gravatar of msgkings msgkings
    24. February 2018 at 14:16

    @Patrick: there were many fathers to the crisis, but the most direct reason why we didn’t have a banking crisis like the Great Depression for 70 years was the very sensible mark-to-market rules put in place in 1937 were removed in 2007. Before 2007 you could value your loans based on their value in a reasonable market, using cash flows. After you had to mark them to what they could sell for. In late 2008 that price was close to zero on many perfectly good assets.

    When they leaned on FASB to fix this on March 9, 2009, the stock market bottomed on that exact date and started this massive Obama bull market.

  22. Gravatar of ssumner ssumner
    26. February 2018 at 07:42

    Patrick, You said:

    “Except that we had the FDIC for something like 70 years without a banking crisis.”

    Nope, we had one in the 1980s, also caused by FSLIC. And even when there is no crisis, the system is inefficient.

    Ralph, You asked:

    “Why on Earth should NGDPLT make bank failures impossible?”

    It doesn’t, bank failures would still occur.

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