The Myth of Too Big To Fail

by I. Moosa

Overview

The book presents arguments against the taxpayers'-funded bailing out of failed financial institutions, and puts forward suggestions to circumvent the TBTF problem, including some preventive measures. It ultimately argues that a failing financial institution should be allowed to fail without fearing an apocalyptic outcome.

Product Details

ISBN-13:	9780230277762
Publisher:	Palgrave Macmillan UK
Publication date:	10/27/2010
Series:	Palgrave Macmillan Studies in Banking and Financial Institutions
Edition description:	2010
Pages:	223
Product dimensions:	5.50(w) x 8.60(h) x 0.70(d)

About the Author

IMAD MOOSA is Professor of Finance at Monash University, Australia. Prior to becoming an academic, he was a professional economist and a financial journalist. Professor Moosa has published ten books and over 160 papers in international journals. He has served in a number of advisory positions, including as an economic advisor to the U.S. Treasury.

Table of Contents

List of Figures x

Preface xi

List of Abbreviations xv

1 The Too Big to Fail Doctrine 1

1.1 The meaning and origin of TBTF 1

1.2 Rewarding recklessness: An anecdote 9

1.3 TBTF: A privilege of banks and other financial institutions 10

1.4 The pros and cons of financial regulation 14

1.5 TBTF as an extension of the banking safety net 17

2 The History of TBTF 19

2.1 Financial crises and regulation 19

2.2 The history of deregulation 22

2.3 Evolution of the TBTF doctrine 26

2.4 TBTF rescue during the global financial crisis 28

2.5 Has the TBTF problem become worse? 32

3 Some Notorious TBTF Cases 33

3.1 Continental Illinois 33

3.2 Long-Term Capital Management 35

3.3 The Royal Bank of Scotland 40

3.4 Northern Rock 43

3.5 American International Group 44

3.6 Citigroup 47

3.7 Lehman, Merrill and Bear 50

4 Far Too Big and Politically Connected 54

4.1 No longer humble intermediaries 54

4.2 Internalization and "King of the Mountain" 55

4.3 The quest for market power 57

4.4 Exploiting the economies of scale and scope 63

4.5 A reality check 68

4.6 The big motive: Mission TBTF 69

4.7 Growing big: A recap and evidence 71

4.8 The growing political influence of financial institutions 75

4.9 Victims or villains? 76

5 The Jewel in the Crown 81

5.1 Some facts and figures 81

5.2 Financial markets and financial engineering 86

5.3 The government's love affair with the financial sector 93

5.4 The role of deregulation 95

5.5 The role of academia 97

6 Worthy of Bailout: To be or Not to be? 109

6.1 Cherry picking? 109

6.2 Size as a determinant of systemic importance 111

6.3 Contagion as a determinant of systemic importance 114

6.4 Correlation as a determinant of systemic importance 116

6.5 Concentration as a determinant of systemic importance 118

6.6 Conditions/context as a determinant of systemic importance 118

6.7 A classification scheme 120

6.8 So, does size matter? 121

7 Why Too Big to Fail is Too Outrageous to Accept 124

7.1 Any argument for TBTF? 124

7.2 Argument 1: The difficulty of determining TBTF institutions 126

7.3 Argument 2: Diversion of resources away from more beneficial uses 126

7.4 Argument 3: Boosting rent-seeking unproductive activities 128

7.5 Argument 4: TBTF creates significant moral hazard 130

7.6 Argument 5: Financial burden on future generations or hyperinflation 132

7.7 Argument 6: Saving a minority at the expense of the majority 132

7.8 Argument 7: Rewarding recklessness and hampering market discipline 133

7.9 Argument 8: TBTF as a source of poor performance 135

7.10 Argument 9: TBTF creates distortions 136

7.11 Argument 10: TBTF makes big institutions even bigger 137

7.12 Argument 11: Boosting the financial sector even further 137

7.13 Arguments against for all tastes 138

8 Dealing with the Menace of TBTF 139

8.1 Why TBTF should be tossed in the dustbin 139

8.2 The million dollar question 140

8.3 Fighting the obesity of financial institutions 142

8.4 Appropriate and effective regulation 150

8.5 Allowing failing financial institutions to fail 161

9 Forget about Basel II 171

9.1 Basel II in the aftermath of the global financial crisis 171

9.2 The Basel Accords 172

9.3 Basel II as a form of capital-based regulation 174

9.4 Basel II: The wrong kind of regulation 174

9.5 The treatment of liquidity and leverage 176

9.6 The use of internal models 180

9.7 Risk sensitivity and procyclicality 185

9.8 Reliance on rating agencies 188

9.9 The implementation problems 189

9.10 The exclusionary and discriminatory aspects of Basel II 190

9.11 The one-size-fits-all problem 192

9.12 Basel II as a pure compliance exercise 192

9.13 Concluding remarks 193

10 TBTF: Where Do We Stand? 195

10.1 The costs and benefits of TBTF 195

10.2 Circumventing the TBTF problem: Why and how? 196

10.3 Regulation: The way forward 197

10.4 No more business as usual 198

10.5 Basic finance without TBTF 199

References 201

Also Imad A. Moosa 216

Index 217