Banks Have Become “Too Big To Fail” Again. Uh-Oh.

Commentaries on economics and technology.
April 28 2013 7:15 AM

Banks Have Become “Too Big To Fail” Again. Uh-Oh.

And there’s only so much governments are willing to do about it.

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This form of government support amounts to a large implicit subsidy for big banks. It is a bizarre form of subsidy, to be sure, but that does not make it any less damaging to the public interest. On the contrary, because implicit government support for “too big to fail” banks rises with the amount of risk that they assume, this support may be among the most dangerous subsidies that the world has ever seen. After all, more debt (relative to equity) means a higher payoff when things go well. And, when things go badly, it becomes the taxpayers’ problem (or the problem of some foreign government and their taxpayers).

What other part of the corporate world has the ability to drive the global economy into recession, as banks did in the fall of 2008? And who else has an incentive to maximize the amount of debt that they issue?

What the two narratives about financial reform have in common is that neither has a happy ending. Either we put a meaningful cap on the size of our largest financial firms, or we must brace ourselves for the debt-fueled economic explosion to come.

Simon Johnson is a professor at MIT’s Sloan School of Management and the co-author of White House Burning: The Founding Fathers, Our National Debt, And Why It Matters To You.