Banks: the problem with ‘too big to fail’

We hear it time and again.  Such-and-such bank is too big to fail. To me, that simply means too big. A bank failing needs to be like a ripple in a pond not like a tsunami crashing all before it and leaving a wasteland behind it.

There’s just something very wrong with the banking industry. In virtually every other industry corporate failure (or basically going bust) is the market punishing poor decision making by that organisation’s management. It’s a good thing. A company makes some bad decisions and the people in charge get feedback about those decisions in their company losing customers, money, both or even just going bust. A company making good decisions is rewarded in the market and keeps going.

And a company going bust is actually good feedback; it’s doing something wrong in the market. The people working in it should be released back into the labour pool where they can be employed by other companies that are making the right decisions in the market. This, of course, requires a near-perfect market where lots of little companies are providing services in the market.

However, in the UK, Northern Rock, RBS, Lloyds et al. made incredibly poor decisions about how to invest their money.  The lost staggering amounts of money on their little pyramid scheme when over-inflated property prices crashed and mortgages were defaulted on by people who should never have been given the mortgage in the first place.  Pure Greed.  But it would’ve been okay if their gambling had paid off.  They didn’t, and the banks didn’t get to feel the pain of their mistakes.  And that’s because, we, the tax payer bailed every-last-one-of-them out.

So they’ve learnt nothing. In fact they’ve been rewarded for their incompetence. Not only do the banks get to lose bigger-than-telephone-number amounts of money, but they now know, if they do, they’ll simply get their customers to bail them out one way or another.

What’s the solution? I don’t know, but one method might be to make them small enough so that when they fail, we get a ripple and not a tsunami. And maybe regulate them so that the gamblers don’t get to take down the mortgage providers, day-to-day business providers, and the consumer/retail banks. Obviously, it’s more complex than this, but it might be a step in the right direction.