ADDRESSING TOO BIG TO FAIL.

ADDRESSING TOO BIG TO FAIL. Since the collapse of Bear Stearns and Lehman Brothers, we have lived with the risk that another institution that is too big (or too interconnected) to fail will in fact fail and require rescue. The danger is still enormous. Some steps have been taken toward reducing the probability that some institutions may fail by, for example, getting them to increase the amount of capital they hold. Even some of those measures are directed to achieve results only in some years from now. But very little has been done about the second half of the equation: reducing the number of institutions that are too big to fail. Gretchen Morgenstern had an article in the September 22 New York Times (link via RealClearPolitics) which reported on a speech by Paul Volcker about what remains to be done to address the problems with our financial system. Here is the speech. There is an underlined caption in the middle of page 8: “‘Too Big to Fail’—the Key Issue in Structural Reform.” Volcker says that the Dodd-Frank legislation took “limited but important steps” forward on the problem of “too big to fail.” In particular, there will be a cap on the assets of financial institutions. I find it very troubling that the cap is slightly higher than the current size of the biggest of the United States institutions. As Volcker points out, the problems are difficult intellectually. Nevertheless, nothing will be done about the institutions that are too big to fail right now. And there are a lot of institutions that are as big as or as interconnected as Lehman. (This wikipedia article gives an idea of magnitudes: Long-Term Capital management lost on the order of $4.6 billion dollars to precipitate its bailout in 1998). “Too Big to Fail” looks to be with us for a long time.