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Steve Saville: The "Too Big to Fail" Lie (as applied to US banks)

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February 23, 2010 – Comments (0)

The "Too Big to Fail" Lie (as applied to US banks)
by Steve Saville

February 22, 2010


[excerpt]    

"They are too big to fail" was the reason given for using trillions of dollars in money and guarantees to 'bail out' several large US banks during 2008-2009. Their failure, it was argued, would all but bring the entire economy to a standstill; such were the size and scope of their operations. Providing the banks whatever financial support they needed to remain in business was therefore touted as serving the "public interest". However, the "too big to fail" argument was a giant, multi-faceted lie.

One part of the lie was that rescuing the banks would ensure the continued flow of credit to private individuals and businesses. It is now blatantly obvious that this was not true because bank lending has been in decline ever since the bailouts. Although, perhaps we are being unkind and it should be put down as a basic misunderstanding stemming from the popularity of fallacious Keynesian economic theories.

The crux of the lending issue was/is that the pool of real savings became severely depleted during the inflation-fueled boom of 2003-2007. It should therefore be no surprise that the private economy has since been desperately trying to replenish its savings, and, as a consequence, that there has been less desire and less ability to create new debt. Once the real issue is understood it becomes clear that the banks were never likely to quickly return to their old lending habits and that it would be bad for the economy if they did.

A second part of the lie was that depositors were at risk, when it was actually just the bond- and equity-holders of the banks that were at risk. The bailouts were essentially carried out to prevent the owners of bank bonds from taking losses on their bad investments under a policy that could be aptly named "no bank-bondholder left behind".

A third part of the lie was more a misdirection than a lie, because the ultimate source of the funds for the bailouts was deliberately kept vague. There was always the implication that the government was funding the bailouts, but the government doesn't have or generate any real savings and can therefore never fund anything. The harsh reality is that the bailouts involved a massive transfer of wealth from the rest of the economy to the banks' bondholders in the first instance, and later to the banks' managers and traders.

Understanding how government bailouts of failed businesses are funded reveals the overarching lie that a bank or any other business could ever be "too big to fail". The truth is that one business or economic sector can only ever be given artificial support at the expense of other parts of the economy, so the bigger the business the LESS sense it will make, from an economy-wide perspective, to bail it out. Moreover, when a business fails it doesn't just disappear in a puff of smoke; rather, the parts of the business that are economically viable get sold off and resources get freed-up to be used elsewhere. In the cases of the big banks, the underlying banking businesses were healthy and would have continued to operate under different ownership if the banks had been permitted to go bust. (emphasis mine)

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