With our system set up as it is, yes, the major national institutions are too big too fail. Letting them fail in September would have destroyed the credit market, and the credit market is what keeps the economy moving, both the commercial paper market, and long term corporate and small business debt. Letting the banks fail would have resulted in a Depression, capital D, and one that would have had a decade or longer recovery time.
But it doesn't have to be that way, and we certainly should not have facilitated the mess of mergers that occurred in the wake of presumptive failures. That exacerbates the problem, making these megabanks larger, and making the consequence of their failure more serious. Shielding them from failure makes matters worse.
So they must be allowed to fail. We must first examine why their failure would be so damaging, and how to let them fail in a way that lessens the impact on us.
In case you haven't read my previous diary entries, let me start by saying that I have my securities licenses and work for a brokerage. I get to spend my entire day watching the market and seeing it react to news. Let me also begin by explaining how business debt works.
If you think about small business debt, it's fairly simple. Get a $200,000 loan and use that open your restaurant, repaying the loan out of your revenue. Decide to take a $50,000 loan so you can buy a second van and begin providing electrical service to another area. Borrow $1 million to get another robot and hire four more workers so you can operate a third shift. This is what the Small Business Administration excels at, but there are obviously private lenders as well.
Commercial paper is quite different. These are extremely short term loans, often overnight, but at the absolute longest thirteen months. The overwhelming majority are under 90 days. If you have $800,000 in expenses to be paid today, only $300,000 in the bank, but you know tomorrow you get paid $1,000,000, you might take out a $500,000 loan for overnight. Tomorrow, you pay back not interest, but a premium, and give the lender $505,000. It's inexpensive, simplifies your business, allows it to run more efficiently, and increases the velocity of money. The entire economy runs on it, and it's one of the finest improvements to the modern economy ever made. Money market funds are one of the largest buyers of commercial paper.
Large commercial and investment banks are the overwhelming providers of both. The failure of one money market fund froze the commercial paper market entirely, resulting in the loss of hundreds of thousands of jobs. The credit crunch resulted in small businesses being rejected for loans to expand, regardless of credit history, simply because the banks were terrified to lend. They wanted and want their capitalization numbers to look good so that the FDIC doesn't swoop in and declare them insolvent. Bank of America may not like it that their stock is now in single digits, but they prefer that to having their stock be worth pennies. The failure of all these banks would still cripple our economy.
So how do we get out of this trap? First things first. We need an alternative for credit. I've said it before and I'll say it again. We need to expand the Small Business Administration to the point that it would be capable of quickly scaling up to replace any failure in the commercial lending system. Ideally, I would like to see a large bank with "SBA" on the front doors in every city with 100,000 or more people in it, functioning as a low cost consumer bank, and using those deposits, along with billions in taxpayer dollars, to fund loans for small businesses. The only way I would approve of securitization of those loans would be with an explicit government guarantee, but I would prefer that it act like an old fashioned bank, making a small profit on the difference between interest paid on deposits and received on loans.
So if Wells Fargo decided to sit on its deposits because some gambles had failed, and was refusing to lend, people would have an alternative. The new restaurant, the second van, the third shift would all be able to happen.
Second, allow and mandate that the Fed operate its own money market fund, and make it big. This would take care of commercial paper, ensuring that if Chase was too scared to make a simple overnight loan, someone would. The Fed and the Treasury are already backstopping money market funds and buying commercial paper. It's a pretty short step to issuing it as well.
With those in place, the failure of even the largest megabanks has in impact, but not one that we can't recover from and quickly, at that. Wherever the market is freezing, our federal institutions would step in and be able to offer expanded credit, which we would make money on, instead of sinking it into bad banks.
So immediately, we could allow banks to fail. We wouldn't have to engineer shotgun marriages over the weekend, "before the markets open in Asia." The FDIC would take a serious hit in the first few years, but the end of national banks would pave the way for the resurgence of regional and local ones (which is so much better. I walk into my one branch bank and they know my name, offer me coffee, and notarize stuff for free). I will also note that the rise in fees and decrease in savings account interest rates coincided with the rise of national banks.
And then we could enforce some fucking anti-trust laws. This is the aspect that fills me with rage more than any other. This entire damn debacle would likely have been avoided if we had just prevented mergers and growth to dangerous sizes in the first place. When Washington Mutual started, it was a local Seattle bank and eventually a regional bank. If it had remained that way and failed, then damn, that would have sucked for me, because Washington, Oregon and Idaho would have experienced some of the blowback, while California, Florida, and Maine would have said, "Hmmm...what's Washington Mutual?" By allowing it to consume other banks until it was a behemoth whose fall would crush hundreds of millions of Americans, regulators failed.
I say, never again. If we put a system such as the one I've described into place and some national banks survive, I would envision a Ma Bell level of breakup. And when the next behemoth began forming, I would expect the Justice Department to be tunneling beneath them from the time they expanded into their third state. If we take all these steps, too big to fail will lose all meaning.