I was listening to the podcast “Moral Hazard: The Long-Lasting Legacy of Bailouts” by William Poole. It’s on the CFAI website (http://www.cfawebcasts.org/publishing/article.cfm?article_id=19). In the presentation, Poole is discussing the “too big to fail” issue and suggests that the use of subordinated bank debt could be used to control the size of firms. My understanding is that banks would have to issue 1% of their total liabilities in subordinated bank debt annually. The subordinated bank debt would be in 10-year notes, so at any given time banks would have 10% of liabilities in subordinated bank debt. If a bank is unable to sell 1% of subordinated bank debt in a given year they would then have to (contract) reduce liabilities such that subordinated bank debt still represents 10% of the liabilities. I’m sure I’m over simplifying the concept. I found the idea intriguing. Is anyone else familiar with this concept? Is there any validity to the idea? Would it be a practical way to control the size of financial institutes?
JonnyDee Wrote: ------------------------------------------------------- > I was listening to the podcast “Moral Hazard: The > Long-Lasting Legacy of Bailouts” by William Poole. > It’s on the CFAI website > (http://www.cfawebcasts.org/publishing/article.cfm > ?article_id=19). In the presentation, Poole is > discussing the “too big to fail” issue and > suggests that the use of subordinated bank debt > could be used to control the size of firms. My > understanding is that banks would have to issue 1% > of their total liabilities in subordinated bank > debt annually. The subordinated bank debt would be > in 10-year notes, so at any given time banks would > have 10% of liabilities in subordinated bank debt. > If a bank is unable to sell 1% of subordinated > bank debt in a given year they would then have to > (contract) reduce liabilities such that > subordinated bank debt still represents 10% of the > liabilities. I’m sure I’m over simplifying the > concept. I found the idea intriguing. Is anyone > else familiar with this concept? Is there any > validity to the idea? Would it be a practical way > to control the size of financial institutes? It looks like the idea is the market will decide when it no longer wants to purchase more debt…that’s no different than it was, except he’s added in an arbitrary limit, it doesn’t matter what the mechanism is. It could be structured many different ways. If the point is to avoid having banks that are too big to fail, simply setup a limit on size. If the point is to make a size limit while also dictating a certain capital structure…then just do that. Seems to me like we’re over complicating again, no?