The year is 2008 and you are an average American taxpayer who just moved into their Ford F-150 pick-up truck. Not only are your investments for retirement at their worst performance, but you are also paying taxes to bail out one of the institutions which provoked this disaster.
For the past decade, those well-dressed individuals on Wall Street created a financial nuclear weapon). Did they know what they were doing and chose to ignore the consequences or were they complete ignorants? We will never know. What we know is that their “deals” caused the worst financial crisis in the past 70 years. But what happened to the banks they worked for after the crisis? Were they locked in prison, did the banks fail? Of course not. Although smaller banks failed, the biggest financial institutions in the US and the world were bailed out with taxpayers' money.
The 2008 financial crisis is the perfect argument for the break up of large banks into smaller ones. Some argue that if a bank knows it is too big to fail, then it will start making risky moves looking for larger profits for its owners and employees. However, this risk is hedged with taxpayers' money leading to deficits in the government budget. On the other hand, too-big-to-fail banks are considered to be safer alternatives as the depositors’ money is always given back, even during heavy crises. This is the reason why many US citizens moved their savings from regional banks such as the Silicon Valley Bank to enormous financial institutions such as Goldman Sachs or Morgan Stanley. Both views have advantages and drawbacks, but they seem a bit too extreme for a sensible person. Is it okay to let for-profit corporations operate however they want? Is it safe enough for the average person to risk their life savings by using a regional bank?
First of all, I think most people can agree on the fact that it is much easier to make a choice out of 6-10 safe choices (you can not lose your savings) compared to hundreds of risky choices (if the bank goes bankrupt, you’ll lose all your money). One solution that we can think of is diversification. To put it simply, citizens can deposit certain percentages of their capital in different banks. Even if this solution reduces the risk of average taxpayers losing money, it is very difficult for common people to manage assets in so many institutions. This is why I think it is fair to say that big banks should still be kept as they are.
In my opinion, the most elegant solution combines “ring-fencing” and “bail-in mechanisms”. Ring-fencing is the separation of banking operations. For instance, delimiting the riskier investment operations from the usual retail processes (savings accounts, checking). Bail-in mechanisms are harder to understand and as a result, we will use the example of Bank A which is presumably owned by me, the writer. Let’s now consider that you, as an investor, lent me money. In fancy words, you are my creditor and now I owe you money. But my bank goes bankrupt because I used the depositors' money for my interests. What now? I only have enough money to pay you or the depositors. So, I’ll pay the depositors and now your debt will be converted into equity. Basically, the government will force you to become an owner of my bank and forget about your debts.
Even though solutions have been proposed, 2 Big 2 fail banks will probably still exist in the coming years.
Bibliography:
Macroeconomics, 9th Edition, N. G. Mankiw
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