Sensible Regulation For “Too Big To Fail” Companies.

(11 am. – promoted by ek hornbeck)

Crossposted at Square State

There is a lot of talk about the way which we need to go in order to fix our current very serious problems in the financial sector and the economy in general. There can be very little doubt one of the major causes of our crisis is the repeal of the Glass-Steagall Act in 1999. Now the Dog knows that some of his reader’s eyes are going to glaze over when the old hound starts to talk about economic policy, but he promises not to make it too dry and boring. Besides, none of us can really have an informed opinion if we don’t wade through this stuff.  

The Glass-Steagall Act was put into place in 1933 as a response to the problems of the banking system collapse at the start the Great Depression. The basic premise of this act is to keep to very different types of financial business from being under the same corporate roof. The first type of financial institution is banks, the type of bank you think of when you think of your checking account. These are places that have depositors and use that money to make loans on houses or cars or whatever. Often these banks are owned by what is called a “bank holding company” which is basically a company that can own other banks. The advantage of being a bank holding company is there are less regulations and it is easier to raise money and acquire other banks.

The other type of bank is an “investment bank”. An investment bank is one which sells raises money by selling securities (bonds) and also sells insurance on bonds (things like Credit Default Swaps). As you can see the way that each of these companies makes money is very different. One of the reasons that Glass-Steagall was put in place was to prevent the commercial bankers who had lots of cash from using it to make risky investments in securities and bond insurance. There was too much chance for abuse and overleveraging the depositor’s money (which is basically using the same money multiple times). If the investments went bad, the depositors would be wiped out since their money was promised multiple times, and there would not be enough money to go around.

Now we fast forward to 1999, when the Gramm-Leach-Bliley act repealed the Glass-Steagall Act and allowed bank holding companies to buy investment banks. It is hardly surprising that when this regulation was repealed the exact same problems that helped the Great Depression to form cropped up again. The way that G-L-B was written made the regulation of banks much harder as they become more than investment banks or commercial banks, they became “financial service companies” where they could offer all these service under one corporation. These banks immediately began to use their enormous cash reserves to leverage there investment banking side and the boom was on.

The above is a really scaled down version of what has happened, the question becomes what should be done to prevent this from happening again. The problem which Glass-Steagall tried to address is one that we will have for as long as there is an investment banking business. There is no doubt that when we are talking about companies that either nominally or actually control trillions of dollars of assets that they can not be allowed to be unregulated. The damage that such companies do when they fail is clear for all to see. This is the origination of the idea of “Too Big To Fail”. If we let these mammoth companies collapse they are going to in a very real world way, take the rest of the global economy down with them.

In a capitalistic economy this is unacceptable. It is risk that can not be modeled accurately and therefore can not be managed. At the same time there are advantages to having markets for securities. If managed correctly, it allows companies, cities and other groups to raise capital in a much less expensive fashion and so allows your economy to grow more quickly and more innovatively than would otherwise happen. This means that it comes down to a way to balance the need of the world and our nation to have a secure economy with the need to have one that is open enough to allow growth and prevent the biggest companies from overshadowing all the little ones that might someday replace them.

Regulation of the Credit Default Swap and Credit Default Obligation markets is a no brainer. Any time you let anyone insure anything you must have someway to make sure they have the resources to pay out when disaster hits, you must have someway to assure they are staying within reasonable risk boundaries and that if the worst happens there is some way for the Federal Government to step in, take over the company and wind it down without a domino effect. We are very likely to get this kind of regulation, but the history of Glass-Steagall also shows that we need something more.

What we need is a way that allows the companies to grow, but limits their ability to get so massive where, without being a monopoly, their failure can endanger our entire economy. To this end the Dog proposes this idea; We set an arbitrarily high boundary of, say, 1 trillion dollars. Any time a company gets to the point where they control either nominally or in actuality 1 trillion dollars in assets, or obligations, they have a choice, they can either divide the company into smaller groups, which must be sold off, or they can become a very tightly regulated company, akin to a utility. The profit margin on these gigantic companies would be set at something between 3% and 5% and would be run to keep it there forever.

This would allow those fearless captains of the free market to have the opportunity to build up companies and make tons of money. It would also prevent any company from getting so big that its misdeeds or mismanagement would severely damage the economy. For those that wanted merely to be very rich, they could keep their mega-company together and run it so as to show a modest (though still enormous in absolute terms) profit they could accept this utility status. For those who love to build up an empire of their own, well when they hit the ceiling, they can break up the company and start over, having profited handsomely from the sale of the smaller divisions and do it all over again.

This idea preserves the market mentality that we have currently while providing a level of assurance and stability that is missing in the market currently. While the exact numbers may need some tweezing (it might be that a company needs to be limited 750 billion) the ability to assure there is no company that is “Too Big To Fail” and having it known in advance exactly what that size is and the consequences of getting to that size will provide a much less risky and volatile economic engine going forward.

That is the Dogs idea (with a considerable amount of help from his friend Dan), what do you think?

The floor is yours.    


  1. the bankers as the ones that got us here, but we really need to make sure there is a way where we get the benefits of this type of investing while keeping our collective risk down.  

  2. that repealing Glass-Steagall was going to create a potential disaster.

    My ex-Senator, Chuck Schumer, knew it too:  Check out his NYT op-ed from 1987:

    Citing the pressures of rigorous worldwide competition in financial services, large American banks are pleading for the repeal of the Glass-Steagall Act, a law that keeps banks out of the more volatile and risky world of securities transactions. Their entreaties should be resisted. The reasons the act was passed are still valid, and it has not interfered with our ability to compete internationally.

    The Glass-Steagall Act of 1933 evolved from the bitter experience of the Depression, when American banking was in shambles.


    The answer, of course, is that banks see big profits in securities. But if a bank thinks it can make more money as a securities firm, let it become one. Let’s not destroy a stable structure that, since the Depression, has provided capital for entrepreneurs, confidence for depositors and healthy profits for America’s financial service companies.

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