“Too big to fail.” It was the term du jour in the depths of the financial crisis, and became a pejorative label for greedy, inefficient or lazy institutions that exist because of sheer size alone.
Banks were deemed too big to fail amid global financial chaos as credit markets seized up in 2008. Then Detroit automakers apparently were too big to fail in 2009, lest the American manufacturing sector be erased forever. And now troubled eurozone states like Greece and Italy are too big to fail, lest the entire EU be splintered asunder.
Will we ever be free of the TBTF phenomenon? The sad reality: probably not.
But that doesn’t mean we can’t ensure the cases are much fewer and have much less fallout on the American taxpayer.
Problems of Perception and Deep Pockets
Part of the challenge is perception. It seems that “too big to fail” entities never are identified as such in happier times, because the concept of failure isn’t imminent and few enjoy speculating about doomsday scenarios.
Take Greece as a prime example. At an abstract level, surely everyone always has known that the default of a EU member state would be disastrous for the economic union … but few people considered it a real possibility for Greece. Until the events in 2008 and 2009, of course. And by then it was too late.
The simple answer to this is to learn from the lessons of the past and not let our guard down. In the case of the 2008 financial meltdown and TBTF banks, the Federal Reserve mandated “stress tests” for the major financial institutions in America and has continued to monitor liquidity threats to prevent another credit crisis.
Of course, all this does is prevent a repeat of 2008. Who knows what new and different crisis the world will face in the future.
Another issue is the practical challenge of wearing down a TBTF entity, even when there is a legitimate complaint. Any organization that becomes too big to fail will naturally have a host of political connections, media sycophants and public relation slimeballs willing to protect the moneyed interests of their corporate overlords.
Call me a pessimist, but I don’t imagine any organization that reaches that kind of scale would go without a long, painful and costly fight.
There Are No ‘Free Markets’
But perhaps the biggest head-scratcher is the serious philosophical conflict between two core ideals of capitalism: that successful companies deserve to grow and prosper on the merit of their business without interference, and unfortunate businesses that can’t adapt should justly fail and fall away thanks to their shortcomings.
Except all that touchy-feely stuff about “free markets” rarely turns out to be true.
We all should agree that some regulations are necessary for the pubic good. Surely nobody thinks it an affront to capitalism that FDA rules prevent drug companies from selling sawdust as cancer cures. And surely nobody thinks that it’s acceptable for two or three major players in an industry to engage in price-fixing to gouge consumers.
Heck, even China understands that monopolies are ultimately bad for the national economy as well as normal citizens. Despite a pretty ugly record on business corruption and human rights, even Beijing admits it’s bad to allow businesses to do whatever they please.
The trouble is, of course, that the costs and benefits of most regulations are far from clear-cut, and balancing competing interests is a complicated affair.
Consider the Volcker rule. On one hand, preventing banks to invest their capital as they see fit could be seen as an overly burdensome overreach of regulators. On the other, as illustrated by the financial crisis of 2008 — and most recently the multi-billion trading losses at JPMorgan Chase (NYSE:JPM) — there is something to be said for protecting financial institutions from themselves.
Or take the higher capital requirements for global banks known as “Basel III,” which will start to take effect worldwide in 2013. Requiring banks to sit on more of their cash and lend less will cut off some borrowers and limit economic activity; however, permitting financial institutions to take big risks without having a safety cushion of some kind admittedly is the height of folly.
Finding a comprehensive solution to problems like this involves looking at the issue from all angles and walking a thin line of compromise. That is a daunting task even in the best of times and even when all parties are acting without ego or self-interest.
The Tough Role of Government — and Taxpayers
This balancing act is not unique to banks and financial institutions, as evidenced by the Detroit automaker bailouts.
How do you decide how much help to give a key segment of the American economy? What do you give up when you throw the Darwinism of the market out the window and allow Uncle Sam to decide which businesses deserve a second chance and which ones don’t?
Even in hindsight it’s impossible to tell who is right and who is wrong. It’s pointless to speculate about how the global auto industry would look like without the bailout, or how things would have been different if Lehman would have been propped up instead of falling into bankruptcy. You might as well speculate about what JFK would have accomplished had he not been assassinated or whether Jerry West could compete in today’s very different NBA.
The businesses are huge. The stakes are huge. And the egos of those involved are huge. There are no simple rules to this game.
But that’s no excuse to quit playing and just take the path of least resistance. Constant vigilance is required not just for financial regulations and “too big to fail” banks, but for all corners of the economy. And if members of our government aren’t willing to spend time on the issues that really matter, it’s time to trade them for politicians and regulators who are.
As Dr. Martin Luther King once wrote, “The ultimate measure of a man is not where he stands in moments of comfort and convenience, but where he stands at times of challenge and controversy.” And in today’s challenging regulatory environment and sluggish economy, the character of policymakers is front and center.
When politicians are afraid of voter backlash, we get legislation that is popular but bad for the economy. When politicians are afraid of moneyed interest, we get legislation that is good for corporate earnings but bad for common citizens.
There are no easy answers. But if those in power thought they were getting an easy job when they became a member of Congress or FINRA or the Federal Reserve, they never should have thrown their hat in the ring in the first place.
It might be impossible to ever wind down TBTF banks to a size that is “safe.” And even if it is possible, that doesn’t necessarily mean we should in a free-market economy.
Rather than looking to regulators for a hard-and-fast rule to save businesses and consumers from themselves, we should instead look to regulators to constantly protect the public interest — both businesses and consumers alike — based on the unique problems of the day.
In a perfect world, that’s what government is for, right?
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace??.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves did not own a position in any of the aforementioned securities.