For the longest of time, things progressed pretty much predictably: the usual semi-important credit crunch – usually triggered by an unfortunate event – would be followed by a bit of panic in the markets and the inevitable return to normalcy and usually new heights some time thereafter. The big always got bigger, the small were gobbled up by the big ones getting bigger and the smallest of fish ended up as food, but not always for thought.
How big is big enough? No one can really say, but legislators for the longest of time believed that 10% of the market is a very interesting threshold that should not be exceeded under normal circumstances. So competing bank institutions which were doing quite well, upon reaching that level had to either stop expanding, get involved in various “gray area activities” or, as it recently became evident fail?
To get to TARP money, you jump through a few hoops and then you get a signal whether your bid for taxpayers’ money stands a chance or not. So if failure to get TARP money leaks out, markets will know the bank in question not only is in a bad shape; things are presumed to be so bad that even the government won’t try to help you. So why would private investors do a job better suited to a bankruptcy court according to the self-fulfilling prophecies of the powers that be?
But for those too big to fail, it never came to that. The government came in, provided liquidity (albeit at not too cheap a price!), encouraged and saw through mergers deemed unthinkable just a few months before the crisis. In an attempt to grow the asset base of troubled financial institutions, so that the risk involved becomes less frightening, those too big to fail were allowed to merge with those just about to fail. The new entities, now several times more “too big to fail” than ever before, turned the first profits for themselves and TARP [A nice data set can be found at http://www.washingtonpost.com/wp-dyn/content/graphic/2009/08/28/GR2009082800426.html]
Some believe the profit margins of institutions receiving TARP money exceed those of the broader bank industry. Their earnings announcements was a much needed glimmer of hope for the exhausted and quite probably oversold markets (which again was a positive side effect), but how these earnings came to be is quite a different story.
Were they the result of creative accounting (overstatement of asset valuations remains not too difficult a task despite the fact that the mark to market rule is history) and political pressure to perform?
Every Witch Has Her Own Crystal Ball
Those believing in stress tests and the ability of regulators to foresee chains of events and protect the system via preemptive strikes will probably not be too eager to investigate the ghost that was UK’s Northern Rock; even a cursory view of the spectacular failure of this fine institution, actually the first run on a U.K. bank since 1866 should at the very least shed doubt on the forecasting powers of public sector’s finest.
With its capital ratio at 18.2 percent, well above the bank’s regulatory and internal requirements just a few months before its collapse (they even declared a 30% increase on their dividend just before “accepting” a loan by the Bank of England), there were basically no real signs of what was to come [Source]
Despite the dominant – today – perception to the opposite, regulation almost never works: at its best, it poses an entry barrier to small fish, raises opportunity cost and cost of money; at worst it is a multiplier of corruption. By definition, regulation should have stopped those too big to fail from becoming just that; by result, it rewarded their failure handsomely. And still continues to do so.
23 trillion reasons
People seemed to panic when Mr. Barofsky uttered the now legendary figure of 23 trillion USD as a potential total cost of the bailout [check http://online.wsj.com/article/SB124810729729665611.html for more]. Everyone rushed in to prove him wrong; but despite the fact that it is just a worst case scenario, I think we should also see it under a decidedly different light. It simply tells us, rather emphatically, what we all already either knew or suspected to be true: if everyone runs for cover simultaneously, there’s nowhere to run to.
What we see unraveling before us is a slightly altered variation of this theme: in the present overleveraged environment, the lender of last resort decides that some of those running for cover are picked up and saved for all to see (and returned to society with the commandment to go and sin no more), while for others no such benevolent and omnipotent, forgiving deus ex machina is in sight.
To ask the same question under a different light, our societies never agreed to bailout homeowners who bought overpriced homes, stock, options, gold, oil or suffered a bad beat at the poker table – and quite rightly so, as we did not partake in their former formidable gains either. But we did not agree to fund the very bank that will foreclose on our home; and even if we did, we most certainly did not agree to go about it using the very money we’d use to repay the bank ourselves! Because that’s exactly what the increased taxation starting to invade our future means.
Because I am no pessimist, I have to believe that even in an over-regulated and increasingly autocratic environment, the voice of reason will somehow probably prevail at some point further down the road but until then I find some consolation in the fact that in the US we still more or less (less being just a tad closer to home, however) know where taxpayers’ money goes and how it is used; while in Europe the cold hand that is government acts as a constant reminder of the sad fact that kings have long arms – and their modern successors even longer, it would seem.