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!