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"If a bank is too big to fail, it must be broken up" watch

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    http://www.telegraph.co.uk/finance/5...broken-up.html

    Yay or nay?

    Should the same apply to very large corporations where their failure/breakdown is a threat to the stability of economies and nations? (e.g. Microsoft).
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    Here's a better idea: firstly, guarantee that the government will under no circumstances bail out private firms; secondly, publicize this fact and make it widespread knowledge; thirdly, find some way to tie the government's hands so that it is not able to cave to short term political pressure (would be tricky in the UK, but something like a constitutional amendment could work in the US); fourthly, sit back and let the market mechanism work.

    The theoretical basis is sound. There's a well-known phenomena in game theory called time inconsistency, where what is optimal decision for a player at one time is (forseeably) sub-optimal at a later time. The government reaction to big banks is a perfect example. Another example is this: someone breaks into your house while you are home, wearing a mask. You catch a glimpse of their face, just enough to recognise them and describe them to the police. The robber realizes this, and decides that he has to kill you in order to minimize his chances of being caught. Now, ideally from your position, you'd like to be able to make a bargain with the guy: let me go and I won't tell the police. But this won't work, because although not telling the police is an optimal decision now, once the guy has let you go, the opposite will be the case - you will then have no reason to let him get away, because you are no longer in danger. The upshot is, he kills you. Now, if there was some way to bind your will so that you cannot change your mind after the fact, you'd be better off. It's very hard for a person to bind their will in this way; theoretically, it should be much easier for a government.
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    (Original post by DrunkHamster)
    Here's a better idea: firstly, guarantee that the government will under no circumstances bail out private firms; secondly, publicize this fact and make it widespread knowledge; thirdly, find some way to tie the government's hands so that it is not able to cave to short term political pressure (would be tricky in the UK, but something like a constitutional amendment could work in the US); fourthly, sit back and let the market mechanism work.

    The theoretical basis is sound. There's a well-known phenomena in game theory called time inconsistency, where what is optimal decision for a player at one time is (forseeably) sub-optimal at a later time. The government reaction to big banks is a perfect example. Another example is this: someone breaks into your house while you are home, wearing a mask. You catch a glimpse of their face, just enough to recognise them and describe them to the police. The robber realizes this, and decides that he has to kill you in order to minimize his chances of being caught. Now, ideally from your position, you'd like to be able to make a bargain with the guy: let me go and I won't tell the police. But this won't work, because although not telling the police is an optimal decision now, once the guy has let you go, the opposite will be the case - you will then have no reason to let him get away, because you are no longer in danger. The upshot is, he kills you. Now, if there was some way to bind your will so that you cannot change your mind after the fact, you'd be better off. It's very hard for a person to bind their will in this way; theoretically, it should be much easier for a government.
    So you seriously think that it would be better for the government not to bail out the banks and then reform the system, but to let the system collapse (which would have happened), leading to economic meltdown and a prolonged depression?

    Although of course you made no steps to prove your position, merely gave a long paragraph on game theory.
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    (Original post by hey guysch im kl)
    So you seriously think that it would be better for the government not to bail out the banks and then reform the system, but to let the system collapse (which would have happened), leading to economic meltdown and a prolonged depression?

    Although of course you made no steps to prove your position, merely gave a long paragraph on game theory.
    And neither have you made steps to prove (presumably) your position that letting the system collapse would lead to a prolonged depression.
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    (Original post by Edenr)
    And neither have you made steps to prove (presumably) your position that letting the system collapse would lead to a prolonged depression.
    Ok.

    If banks had not been propped up by governments in various ways, they would have gone the way of Lehman due to the simple fact that they overpriced the risky tranches of the subprime securities on their balance sheets, of which most large IBs had billions of dollars worth. This would mean that, in general, assets<liabilities therefore bankruptcy.

    The willingness of the financial sector to lend to consumers and businesses is critical to the health of the current economic model we have as growth is driven on credit. A lack of credit (due to a lack of banks to loan) will mean severe economic contraction. A period of NO loans, followed by new banks setting up and operating within an economy with negative growth, would inevitably lead to a prolonged depression.

    Although the current government has done very little to reform bank's ability to correctly assess the risk level of assets (which is crucial), surely government intervention in this case is far better than the alternative?
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    It is important to look at why such banks are facing bankruptcy, and the simple answer is that they are making losses most likely because they are engaged in fruitless activities that are not contributing to real wealth. Since such activities cannot be self-sustained, they must be using resources which could otherwise be used to generate real wealth. Letting these banks go to the wall is merely stopping the haemorrhage of wasted resources, and allowing savings to be re-invested productively elsewhere. Further damage is actually prevented. More real savings will now be in the hands of those who actually generate wealth, and they can start investing in wealth-generating activities, which will lead to sound economic growth.

    Without successful reform (which is far from guaranteed), bailing out the banks now will in no way ensure that the same collapses will not happen again. With a bailout precedent set, the incentive to operate sensibly will be significantly weakened.

    And then there are, of course, objections to the funding of the bailout. The required loan would come straight out of the pocket of the productive sector, depriving private businesses of the capital they could use to expand. It's very easy to look at the situation as simply the propping up of a bank, which on the surface seems reasonable enough (maintaining jobs and savings in the short-term), because you don't see the jobs that would be created, the products that would be made, the services that would be provided were the funds used to bail out the banks in the hands of the private sector.
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    It doesnt apply to the real market. Banking is an incestuous industry so they have these special rules.
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    (Original post by Edenr)
    It is important to look at why such banks are facing bankruptcy, and the simple answer is that they are making losses most likely because they are engaged in fruitless activities that are not contributing to real wealth. Since such activities cannot be self-sustained, they must be using resources which could otherwise be used to generate real wealth. Letting these banks go to the wall is merely stopping the haemorrhage of wasted resources, and allowing savings to be re-invested productively elsewhere. Further damage is actually prevented. More real savings will now be in the hands of those who actually generate wealth, and they can start investing in wealth-generating activities, which will lead to sound economic growth.

    Without successful reform (which is far from guaranteed), bailing out the banks now will in no way ensure that the same collapses will not happen again. With a bailout precedent set, the incentive to operate sensibly will be significantly weakened.

    And then there are, of course, objections to the funding of the bailout. The required loan would come straight out of the pocket of the productive sector, depriving private businesses of the capital they could use to expand. It's very easy to look at the situation as simply the propping up of a bank, which on the surface seems reasonable enough (maintaining jobs and savings in the short-term), because you don't see the jobs that would be created, the products that would be made, the services that would be provided were the funds used to bail out the banks in the hands of the private sector.
    I agree with the first bit - banks failed to correctly assess the risk of subprime mortgage loans, thus deceiving themselves into thinking that something unprofitable was profitable. The task for regulators is to improve the assumptions which banks use when creating mortgage backed securities - which is far from certain to happen.

    However, in relation to my previous post, the problem is that there is no "good" solution. Although most of the government bailout expenditure is in the form of guarantees, so will never actually be spent if the banks don't fail, and virtually all the rest is in the form of loans, the taxpayer is likely to incur some cost. However, the question is whether to sacrifice medium term growth prospects virtually entirely (as credit is the way that new money goes into the economy), create mass economic stability, and leave a huge bill for the taxpayer anyway as the government promises to reimburse savers up to £50,000 (I think) per account if the bank goes bust - or take a hit of a not insubstantial amount in the form of a bailout. I think its reasonably clear which one is better - although its the lesser of 2 evils.
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    (Original post by hey guysch im kl)
    Ok.

    The willingness of the financial sector to lend to consumers and businesses is critical to the health of the current economic model we have as growth is driven on credit.
    Why are you so eager to prop up a failed system? As we've seen we're just going to have a repeat in yearss to come.
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    (Original post by hey guysch im kl)
    The willingness of the financial sector to lend to consumers and businesses is critical to the health of the current economic model we have as growth is driven on credit. A lack of credit (due to a lack of banks to loan) will mean severe economic contraction. A period of NO loans, followed by new banks setting up and operating within an economy with negative growth, would inevitably lead to a prolonged depression.
    I find it strange that people take this view of what would have happened. When a capital goods firm such as steel goes bankrupt, the liquidators don't demolish all the blast furnaces and then we all wait for someone to build new ones, leaving us with a steel shortage for years. Rather the profitable assets are simply sold to a new owner. In this case, those profitable assets are bank desks which have made good investments.
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    (Original post by favh)
    I find it strange that people take this view of what would have happened. When a capital goods firm such as steel goes bankrupt, the liquidators don't demolish all the blast furnaces and then we all wait for someone to build new ones, leaving us with a steel shortage for years. Rather the profitable assets are simply sold to a new owner. In this case, those profitable assets are bank desks which have made good investments.
    tbh i don't think the banks selling their old office furniture would reinvigorate the economy
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    (Original post by munn)
    tbh i don't think the banks selling their old office furniture would reinvigorate the economy
    So what? I didn't say it would. (A 'desk' = a sort of department, like 'the equities desk').
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    (Original post by favh)
    So what? I didn't say it would. (A 'desk' = a sort of department, like 'the equities desk').
    nobody appreciates bad jokes these days it's killing me
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    (Original post by favh)
    I find it strange that people take this view of what would have happened. When a capital goods firm such as steel goes bankrupt, the liquidators don't demolish all the blast furnaces and then we all wait for someone to build new ones, leaving us with a steel shortage for years. Rather the profitable assets are simply sold to a new owner. In this case, those profitable assets are bank desks which have made good investments.
    You don't understand the position and so make a misguided analogy. Your analogy assumes that one steel firm goes bust, and that I said anything about assets. In my scenario all banks would go bust, and the time taken for the whole banking sector to recover would be substantial - severely harming growth
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    (Original post by PoliceStory)
    Why are you so eager to prop up a failed system? As we've seen we're just going to have a repeat in yearss to come.
    Its not a failed system, 1 small part of the system failed. If you would like to propose a realistic alternative to fractional reserve banking, please do.
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    (Original post by hey guysch im kl)
    Its not a failed system, 1 small part of the system failed. If you would like to propose a realistic alternative to fractional reserve banking, please do.
    Free banking.

    Governments can't successfully plan industries; we've known this for quite a while now (theoretically, since Hayek and Mises; empirically, since the USSR). Why think that they can plan the money supply any better? I like to compare it with exchange rates: no one in their right mind these days would propose that 9 people sitting in a room should decide the rate at which the pound trades against the dollar - why should it be any different for interest rates?
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    (Original post by hey guysch im kl)
    You don't understand the position and so make a misguided analogy. Your analogy assumes that one steel firm goes bust, and that I said anything about assets. In my scenario all banks would go bust, and the time taken for the whole banking sector to recover would be substantial - severely harming growth
    In the first place that's impossible. All lenders can't go bust as a result of creditors calling in loans for the simple reason that the creditors are lenders too!

    In the second, businesses awaiting liquidation are placed under administration; they don't just shut down.

    The government is 'solving' a problem that already has a well established solution, with a 'solution' that has lots of secondary problems.
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    (Original post by DrunkHamster)
    Free banking.

    Governments can't successfully plan industries; we've known this for quite a while now (theoretically, since Hayek and Mises; empirically, since the USSR). Why think that they can plan the money supply any better? I like to compare it with exchange rates: no one in their right mind these days would propose that 9 people sitting in a room should decide the rate at which the pound trades against the dollar - why should it be any different for interest rates?
    empirically the NHS seems pretty damn fine...
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    If, in the scenario a bank is too big to fail, you've done a pretty terrible job and basically bought yourself a financial crisis. What needs to happen is a decent amount of competition, strict independent monitors to minimise collusion and corruption within the system, and to keep the Government out of there to prevent crony capitalism and allow the efficient working of that sector.

    (Original post by Edenr)
    And neither have you made steps to prove (presumably) your position that letting the system collapse would lead to a prolonged depression.
    To be fair, and without wanting to go into a prolonged discussion, one only needs to look at history - going beyond the 'roots' of the current financial crisis, take a look at the Asian financial crisis and the role of the chaebols (I think that's spelt correctly - been a little while since I last had a look at this). It may not necessarily lead to a prolonged depression, but there's a good chance there will be a heavy economic repercussion to letting the existing infrastructure collapse.
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    (Original post by hey guysch im kl)
    So you seriously think that it would be better for the government not to bail out the banks and then reform the system, but to let the system collapse (which would have happened), leading to economic meltdown and a prolonged depression?

    Although of course you made no steps to prove your position, merely gave a long paragraph on game theory.
    Essentially a moral hazard argument can be employed, though I'm not saying that I lean either one way or the other.
 
 
 
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