Inside Financial Services

Yet Another Wrong-Headed Solution to TBTF

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The Competitive Enterprise Institute’s John Berlau thinks he solved the problem of Too Big To Fail:

 It’s easy to forget that when it comes to bailouts, the financial industry is largely unique. There was virtually no call in recent years to bail out Blockbuster Video, Borders, Eastman Kodak, and, most recently, Radio Shack, even though their bankruptcies cost thousands of jobs and wiped out shareholders

Why? The short answer is that unlike with bank failures, no consumers were threatened with shortages in supply in these other industries, thanks in large part to new entrants. Blockbuster’s customers could stream Netflix or rent their movies from Redbox. Borders customer could order their books from Amazon.

Yet both before the financial crisis and after, there has been a dearth of new entrants in banking. In fact, since 2010, only one new bank has received federal regulators’ permission to open—the Bird-in-Hand Bank in the Amish country of Pennsylvania. [Emph. added.]

If Berlau thinks the TBTF dilemma can be solved by easing barriers to entry to the banking business, he’s deeply, profoundly mistaken—both in fact and in logic, as the lawyers like to say. First, fact: until the financial crisis hit, starting a bank from scratch wasn’t really too hard. Regulators used to routinely issue anywhere from 50 to 200-plus bank charters annually until 2008.  The typical plan for startups then was to make loans and bulk up on deposits in the local community, gain some competitive critical mass, and sell out in a few years at some exorbitant multiple of book value. Happened all the time. But few of  those banking entrepreneurs ever deluded themselves into thinking they were building from scratch an institution that would eventually challenge Citigroup or J.P. Morgan the way, say, Netflix brought down Blockbuster. More broadly, the financial crisis didn’t happen because new, innovative competitors appeared in 2008 that made incumbent banks obsolete. It happened because too many bankers made too many dumb lending decisions.

But Berlau’s more right than he probably realizes when he says that the financial services industry is “largely unique.”  Companies in other industries, like retailing and film manufacture, to cite Berlau’s examples above, don’t need a federal bailout when they run into financial trouble. That’s because there’s already a mechanism in place for them to work through their problems: Chapter 11 bankruptcy. In bankruptcy, the ailing firm receives special super-senior (i.e., debtor-in-possession) financing it can use to keep operating while the firm’s other creditors hash out a resolution. But as a practical matter, troubled banks don’t have that option. Their business is money, remember, and they’re already highly levered. So when a bank runs into trouble, no one will be willing to step in with extra-senior stopgap financing since, if a quick, permanent resolution can’t be arrived at, the emergency creditor stands to take deep losses along with everybody else. That’s why only the federal government is in a position to provide emergency financing to a large, ailing institution. Even if there were 1,000 new banking startups every year, that fact wouldn’t change.

I’m all for entrepreneurship and innovation in banking. But entrepreneurship and innovation can’t solve the too-big-too-fail problem. Only smarter government policies can do that.

What do you think? Let me know!

5 Responses to “Yet Another Wrong-Headed Solution to TBTF”

  1. TxCommunityBanker


    Also, while new “banks” are not being chartered in the numbers we saw in past years, we are seeing increased competition from other financial service companies who are offering payment and lending services in traditional and non-traditional formats and are not regulated the way commercial banks are. Just like your examples above, we could go the way of Blockbuster and the corner DVD and book stores if the government’s heavy hand controls our every move while our nimble competitors continue to gobble up market share of the retail market. The future of our industry calls us to innovate… but it is tough to do in the current environment. Competition always fills the breach.

    • Dewi

      I suppose the difnreefce in profitability of the customer using browsing is because a mobile phone with a browser is costlier than a mobile phone for texting i.e. the customer moves more money causes more transactions and is more of interest to the bank.

  2. etoleary

    Banking’s role is absolutely unique: at least half of our money supply as most narrowly defined (M-1) can be found on the balance sheets of banks in the form of deposits. The balance is in the form of currency in circulation. In a modern economy, we simply can’t have our money debased or completely frozen up by our collective unwillingness to accept it. That’s why this problem is so difficult and so important.

    • Fhris

      BrentonJanuary 12, 2012Check out the Fed’s Beige Book, just released ydtesreay. A pretty dry read as well but might offer you a few hints to the true direction of the U.S. economy. I recommend looking up a few stats related to retail sales, consumer credit, and household spending over the last few months and use them to draw further implications from the reports in the Beige Book. Also, try to identify regional trends and trends in economic development on a basic scale in order to identify indicators of how the U.S. economy has evolved (or not) since 2008. If you do get around to reading even just a little then come talk to me and I can guarantee you a very interesting discussion!-B

  3. bill3

    Since 2008, all banks have effectively been nationalized. Bankers can’t take a dump without approval from the Feds. So, comparisons to other industries make no sense, as you effectively write, Tom.

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