Too big to fail

Can someone explain to me why we are encouraging the consolidation of financial firms into a handful of behemoths when one of the underlying problems of the current crisis requires Uncle Sam to bail out firms because they are too big to fail? Won’t this eventually lead to bigger problems down the road when they inevitably go too far and need help from the taxpayers? I understand the financial benefits to the company’s shareholders on the upside but the risk appears to be too great to the public as a whole. It comes down to the case where heads they win and tails we all lose. I can’t believe it but I think I’ve come to the conclusion that we do need more regulation in the market and that the markets cannot be trusted to regulate themselves.

(that’s what she said)

jc99_99 Wrote: ------------------------------------------------------- > Can someone explain to me why we are encouraging > the consolidation of financial firms into a > handful of behemoths when one of the underlying > problems of the current crisis requires Uncle Sam > to bail out firms because they are too big to > fail? Won’t this eventually lead to bigger > problems down the road when they inevitably go too > far and need help from the taxpayers? > LOL. Yep, that’s a really good question. It’s because everyone is running around trying to solve a set of problems that should have been headed off years ago and in the usual way of things creating all kinds of trouble down the road. > I understand the financial benefits to the > company’s shareholders on the upside but the risk > appears to be too great to the public as a whole. > It comes down to the case where heads they win and > tails we all lose. > > I can’t believe it but I think I’ve come to the > conclusion that we do need more regulation in the > market and that the markets cannot be trusted to > regulate themselves. Wait a minute… How did you get to this conclusion? What regulations are you suggesting?

If all of these ‘behemoths’ have huge banking operations, the govt can put into legislation limits on leverage and raise the size of reserves and thereby make it easier to monitor a few largies. Small shops will begin to pop up here and there again when we have 175K finance professionals sitting on the sidelines. It will be the regulation of these firms that will determine whether we go down this road again.

MattLikesAnalysis Wrote: ------------------------------------------------------- > If all of these ‘behemoths’ have huge banking > operations, the govt can put into legislation > limits on leverage and raise the size of reserves > and thereby make it easier to monitor a few > largies. Small shops will begin to pop up here and > there again when we have 175K finance > professionals sitting on the sidelines. It will be > the regulation of these firms that will determine > whether we go down this road again. It wasn’t really the community banks that got caught by all of this. It will be the big guys in the future again.

I’m not sure how to do it but I think we’ve come to the point where the financial firms need to be split up in some fashion almost like AT&T and Standard Oil. This time not for monopolies but for the systematic risk they present. Otherwise the evolution of Wall Street would eventually lead to a couple of monsters that would eventually blow up and we’d be up the creek again. So what happens down the road when BOA and all of its tentacles in the market flares up? I, of course, don’t see this ever happening because of the inefficiencies that would be added by duplicating functions in businesses that are split up. Regulations would have to be worldwide as well. There’s no way that you could enforce it in the US when you would have giants built up in Asia or Europe. While I am on my newfound liberal/socialists kick, I also don’t understand why hedge funds are allowed to use excess leverage versus an individual investor. I know the theory is that hedge funds cater to “sophisticated” investors. But as we have seen over the past 20 years, if left unwatched, HF or investors in general will eventually get themselves into trouble. It’s like leaving a teenager at home with the liquor cabinet unlocked and leaving for the weekend and telling the kid not to touch the booze. Sure nine out of ten wouldn’t touch it, but the one out of ten that does throws a blowout party and eventually burns the house down to the ground.

jc99_99 Wrote: ------------------------------------------------------- > I’m not sure how to do it but I think we’ve come > to the point where the financial firms need to be > split up in some fashion almost like AT&T and > Standard Oil. This time not for monopolies but > for the systematic risk they present. Otherwise > the evolution of Wall Street would eventually lead > to a couple of monsters that would eventually blow > up and we’d be up the creek again. So what > happens down the road when BOA and all of its > tentacles in the market flares up? > > I, of course, don’t see this ever happening > because of the inefficiencies that would be added > by duplicating functions in businesses that are > split up. > > Regulations would have to be worldwide as well. > There’s no way that you could enforce it in the US > when you would have giants built up in Asia or > Europe. > > While I am on my newfound liberal/socialists kick, > I also don’t understand why hedge funds are > allowed to use excess leverage versus an > individual investor. “Excess”? Hedge fund leverage seems to be the least of our leverage troubles these days. No taking out a $1M mortgage on a $100,000 salary, that’s “excess”. Anyway, there is not “allowed to” except in the relationship between the fund and their broker. You have a relationship with a prime broker and negotiate cash requirements based on risk and funding. Hedge funds almost always have much more sophisticated risk monitoring than individuals. > I know the theory is that > hedge funds cater to “sophisticated” investors. Not an aspect of this question. > But as we have seen over the past 20 years, if > left unwatched, HF or investors in general will > eventually get themselves into trouble. Whaaaat? Because a few hedge funds have blown up, a HF will eventually get itself into trouble? More airlines have blown up than big hedge funds. If this is about LTCM, we settled that problem about 10 yrs ago. > It’s like > leaving a teenager at home with the liquor cabinet > unlocked and leaving for the weekend and telling > the kid not to touch the booze. Sure nine out of > ten wouldn’t touch it, but the one out of ten that > does throws a blowout party and eventually burns > the house down to the ground. Actually, it’s not like that at all.

I think the “too big to fail” issue is about avoiding mass panic, and also mass unemployment. Banks were all leveraged too high on crappy assets, and the need is to deleverage slowly enough that the companies can stay in business (and keep people employed) without causing runs and contagion to other banks. Banks do perform a function (not all useful, but some are necessary), and if too many banks fail, then society can’t get sensible business done. It’s definitely possible that one could try to consolidate companies into monopolies and then move to break them up after a short time. It’s kind of a Chapter 11 bankruptcy for an entire industry, rather than a company.

9 out of 10 wouldn’t touch it? Did grow up in Utah or something? This guy reminds of this: http://www.theonion.com/content/news_briefs/neither_person_in

I’m not talking about community banks… The behemoths are now hybrid depository banks and investment banks and their investment banking side will be less levered due to the depository side’s regulations. So, as a result, smaller investment banks will pop up everywhere and cause this problem again… how do you regulate a company that doesn’t take in deposits? yet facilitates all business transactions in the world? and is therefore vital to the success of capitalist growth? ie. Merrill, Goldman or like was said above, they could spin right off and we could visit this again in 10 years.

Maybe it’s a monopolistic plot. Banks create these securities and then stop buying them from each other. Then they start saying terrible things about their balance sheets so the govt gives them a huge pile of money and tells them they need to become monopolies. Pretty clever.

mwvt9 Wrote: ------------------------------------------------------- > MattLikesAnalysis Wrote: > -------------------------------------------------- > ----- > > If all of these ‘behemoths’ have huge banking > > operations, the govt can put into legislation > > limits on leverage and raise the size of > reserves > > and thereby make it easier to monitor a few > > largies. Small shops will begin to pop up here > and > > there again when we have 175K finance > > professionals sitting on the sidelines. It will > be > > the regulation of these firms that will > determine > > whether we go down this road again. > > It wasn’t really the community banks that got > caught by all of this. It will be the big guys in > the future again. It was the community banks 18 years ago and not the big guys. The time before that it was the big guys and not the community banks. And the time before that it was the …

JoeyDVivre Wrote: ------------------------------------------------------- > Maybe it’s a monopolistic plot. Banks create > these securities and then stop buying them from > each other. Then they start saying terrible > things about their balance sheets so the govt > gives them a huge pile of money and tells them > they need to become monopolies. Pretty clever. Heh heh, that’s cute… except for a monopoly, as in Highlander, “There can only be one.”

Do you agree that the limitations put in place following the crash/depression were good for the markets (ala borrowing limits of 50%)? I just think that if given the opportunity - I don’t intend to limit this problem to just hedge funds but ibanks/mortgage brokers, etc. - will push the system to the brink to earn an extra buck today with the risk falling to others if it fails. My response in the past would have been, who cares if a couple guys blow up and go bk. But recent events portray this as akin to the speed limits on highways. There are always cars that will be going way over the speed limit. We can live with a couple cars a year crashing but if everyone can drive at dangerous speeds it puts the society at risk every time you get into a car. On a macro level, its a game of heads I win and tails everybody loses.

jc99_99 Wrote: ------------------------------------------------------- > Do you agree that the limitations put in place > following the crash/depression were good for the > markets (ala borrowing limits of 50%)? I just > think that if given the opportunity - I don’t > intend to limit this problem to just hedge funds > but ibanks/mortgage brokers, etc. - will push the > system to the brink to earn an extra buck today > with the risk falling to others if it fails. > I agree that there was a huge pile of legislation put in place during the '30’s. Some of it was useful, and some of it was decidedly un-useful. 50% margin limits on retail investors might be useful. > My response in the past would have been, who cares > if a couple guys blow up and go bk. But recent > events portray this as akin to the speed limits on > highways. There are always cars that will be > going way over the speed limit. We can live with > a couple cars a year crashing but if everyone can > drive at dangerous speeds it puts the society at > risk every time you get into a car. > Society is at risk every time I get into a car. That’s why I bicycle mostly. What does this have to do with anything? > On a macro level, its a game of heads I win and > tails everybody loses.

In my history courses, I remember a big discussion on how buying stocks on margin contributed to the 1929 stock crash. Small declines triggered margin calls triggered forced selling triggering larger margin calls triggering more forced selling, etc. in a chain reaction. I recall that at the time, individual investors could buy stock with 10% margin, so you had 10:1 (or is that 11:1) leverage. The conclusion was that the 50% margin rule was much safer because you could have substantially larger swings before the forced selling vicious circle would be initiated. When I learned about futures and how futures contracts worked (that was CFA Level 1 exam in 2005), and they told me that you needed to put down only 5% margin on the notional value, I thought: “Wow, that means you could theoretically leverage up to 20:1… which flies in the face of all those regulations that tried to control excessive leverage. Why do they allow that? Is there something ‘safer’ about using futures than about using stock that allows this kind of leverage? If not, won’t everyone just leverage up like before?” I never fully answered this question to myself, but I think there are two parts to the answer (which push in opposite directions). 1) The expansion of futures markets and their extensive use on stocks and indices took place mostly in the post-Reagan era, so previous regulations did not cover them, and when these tools were introduced, we were already in an environment that was anathema to regulation. So these tools were introduced with little or no regulation on them. 2) Futures have the possibility of being hedged, which made them appear less risky, I suppose. But the systemic effects of this hedging need to be thought through a little more.

As a practical matter, leveraging up 20:1 on an S&P futures contract doesn’t exactly happen. If you called your broker and asked him to do that, he almost certainly wouldn’t. Anyway, derivatives is all about risk not leverage. The vol on a 20:1 S&P position would be enormous (especially now) and you would only do that if you were a nut or you needed the vol to compensate for highly unvolatile positions. Of all the statistics that I have ever calculated for risk on futures positions, anything that looked like notional/margin are among the least useful.

jc99_99 Wrote: ------------------------------------------------------- > I can’t believe it but I think I’ve come to the > conclusion that we do need more regulation in the > market and that the markets cannot be trusted to > regulate themselves. I think we need ‘efficient’ regulation…additional laws won’t help when the regulators are asleep at the wheel…like we have seen…

It wasn’t a HF this time, although the next time it could be. In fact, so many people we’re probably focusing on HFs blowing up, that they forgot to look at the big banks. It’s funny how report after report it always turns out that the HF is on the winning side of these bad trades and the big banks are on the losing side. Maybe a scattered market is more stable. I used to think it was unfair to restrict HFs to millionaires because of their risk (I can create a more risky portfolio in five minute at my e-trade account then any HF out there), but aren’t HFs hedged? Doesn’t that mean they’re safer, at least relatively, than the long or short only? But now these restrictions may come in handy. The concentration of capital in these accounts means that the gov’t (for lack of a better word) can basically screw the HFs over with minimal political damage. Consider all the HFs holding long CDS position in LEH, BSC, AIG, etc. chances are they’ll get some of the $$ back (through direct repayment by uncle sam), but I would guess that whole bunch of these winners won’t be able to cash in. Now imagine if it was a pension fund (and I know pensions have big position in HFs, but for the most part HFs are funded by really rich guys), state gov’ts, local gov’ts, or even larger companies like those that have defaulted, the gov’t would have significantly more pressure, both economically (counter-party default may have a more significant systemic effect in these groups than HFs) and politically (simply more voters), to make good on most, if not all, of these losing positions.

artvandalay Wrote: ------------------------------------------------------- > (that’s what she said) Best post I’ve ever read on this forum.