December 07, 2013
Neil Irwin seems to miss the major issues on too big to fail in his discussion of Treasury Secretary Jack Lew’s remarks proclaiming too big to fail (TBTF) to be sort of over. The most obvious issue is simply whether the markets believe TBTF is over.
This is a question of whether they think Jack Lew or his successors will simply wave good bye if J.P. Morgan, Goldman Sachs, or one of the other megabanks goes under. If they don’t believe that the government will just let one of these banks sink then they will still be willing to lend money to them at a below market rate since they are counting on the government to back up their loans.
This below market interest rate amounts to a massive subsidy to the top executives and shareholders of these banks. Bloomberg news estimated the size of this subsidy at $83 billion a year, more than the cost of the food stamp program. Insofar as Lew’s efforts to create doubts about a government rescue are successful, the size of this subsidy would shrink toward zero. However as long as the markets do not take him seriously (my bet is they don’t), the big banks will still be getting a massive subsidy.
This is one of the reasons why President Obama’s recent comments on inequality were seriously misplaced. He said the government cannot stand on the sidelines as the distribution of income becomes much more unequal. Of course government is not standing on the sidelines; it is actively working to increase inequality through measures like the TBTF subsidy.
The other point that Irwin gets wrong is implying that the economic crisis in some way hinged on getting the TBTF issue right. The economy’s current weakness is attributable to a lack of a source of demand to replace the demand generated by the housing bubble. Investment and consumption are both at normal levels relative to the size of the economy; there is no evidence that the residue of the financial crisis is holding them back.
The issue going forward will be whether we have people at the Fed and other regulatory agencies who take bubbles seriously. We clearly did not in the past and since no one faced any career consequences as a result of this gargantuan failure, there is not much reason to believe that lessons have been learned.