In my current editor’s letter, I mentioned in passing that a return to a Glass-Steagall type of regulatory framework would not be a practical solution for the too-big-to-fail problem. During the copy-editing process (yes, we have that), a couple of people asked me why.
So in a nutshell, here it is: Even with a law separating commercial banking from investment banking and insurance, I don’t believe we’re prepared to leave the big, systemically important companies out in the cold in times of trouble.
Advocates are calling for a separation of commercial banking from riskier financial pursuits. But even if we partition the financial landscape this way, and give our best tough talk that the riskier financial companies will be left to fend for themselves in times of trouble, it won’t happen. Uncle Sam will want to lend a hand when any firm threatens to push the economy over the edge. And it should. A cynic would note that there are jobs and votes that hang in the balance, but a more dispassionate observer would also see that avoiding recession is a valid use of government power.
When the car companies found themselves in hot water during the crisis, the government included them in the bailout. When hedge fund Long Term Capital Management imploded in the 1990s after using a risky arbitrage strategy, the government orchestrated a bailout package. These rescues leave the public disgruntled. After all, the idea of private gains but socialized losses strikes most of us as profoundly unjust.
And lest you think this is all a recent phenomenon, consider the Panic of 1907. The big banks got a bailout from J.P Morgan himself (the Federal Reserve didn’t exist yet). Not really the same thing since it wasn’t a government bailout, but it still fits an American pattern: We press full-steam ahead in business, but when necessary, we’re not above accepting a bailout. The episode of 1907 does share one similarity with the recent crisis. After J.P. Morgan bailed out the banks, there was a deep mistrust of Wall Street on the part of the public—even though it wasn’t public money providing the safety net.
The next time a big company is in that situation, whether it’s next week or 20 years down the road, I don’t see any reason to think that the collective mind-set would be different. That is, we’ll want government to save the jobs and the economy now, and deal with the resentment later.
So if we conclude that in the face of a recession, government will do whatever it can to help, then the question becomes “How should we go about it?” And I think it’s pretty much what we’ve been doing. We can demand new management and institute new checks on risk levels. We can file lawsuits and demand the occasional pound of flesh. We can even vote a lot of politicians out of office. But more than anything, it will be a matter of pressing ahead, while acknowledging that if necessary, we’re okay with a bailout. And we’ll deal with the anger later.