We Don't Need "Too Big To Fail" Institutions

They shared a view that what we experienced back in 2008 was the mother of all liquidity crises. As one of them put it, the crisis boiled down to this: the world missed a payment, then all hell broke loose. To summarize this view, we had a highly leveraged and interdependent financial system that relied on extremely short-term borrowing (overnight) to finance positions in assets.

A key link in the liquidity chain was the money market mutual fund, which essentially promised close substitutes for bank deposits, but without the government guarantee. MMMFs purchased very short term debt issued by the shadow banking system (held as assets). When it looked like forces would “break the buck” there was a massive run on the money markets which made it impossible for the MMMF's to continue to provide overnight funding to the shadow banks. This is a $3 trillion uninsured “deposit-like” market that the government had to guarantee dollar-for dollar. All told, the bailout of Wall Street amounted to more than $29 trillion (that is the “flow” number; the outstanding stock maxed at perhaps $8 trillion—still a very big number). That is what happens when the world “misses a payment”.

While this is not the topic for this blog, just think about the possibilities if $8 trillion (leaving to the side $29 trillion) had been devoted to bailing out Main Street rather than Wall Street. We'd be fully employed, driving brand new SUVs, and making payments on our overpriced MacMansions. All that is too obvious to require any explication. Now, I think these guys are wrong. Dangerously so. What we actually had (and have) were massively insolvent Wall Street shadow banks, so their short term liabilities were trash. The run on MMMFs was not an irrational liquidity run, but rather a rational run on institutions that were holding garbage as assets. The federal government made that garbage as sweet smelling as roses, by intervening in the biggest bailout in human history, by several orders of magnitude. And it did not have to be that way.

Let us instead deal with a “what if”. Suppose we had decided not to bailout the MMMFs and let the insolvent shadow banks go down. What if we had not handed bank charters to Goldman Sachs and Morgan Stanley (the last two investment banks standing)? What if we had simply closed down what my colleague Bill Black calls “systemically dangerous institutions”? What if we had let the market “work”—in its wisdom it wanted to close down the biggest financial institutions and to rid the world of shadow banking. What if we had let that happen?

in medias res: The vampire squid from hell

Its large eyes may appear blue or red, according to the light (I'm guessing the "cloak" and red eyes account for its name). The arms that are missing on the octopus, and which are tentacles on a true squid, are, for the vampire squid a pair of extra-long, filament-arms, used to sense prey (which is then caught by the 8 standard arms). These are kept tucked away when not in use. Vampyroteuthis breathes just fine at oxygen levels of as low as 3% in the really deep sea, and does not change colors like cephalopods from more shallow depths, but is covered in photophores that it uses to disorient prey -- again, maybe the idea of vampire-like attributes (hypnotic power?) and its home in the way-deep depths contributing to the name.

Lake and Sea Monsters

On the Destiny of Species, By Means of Natural Selection, Or the Elimination of Unfavoured Races in the Struggle for Life

Vampire Squid

Encyclopedia of the Aquatic World: Newt and salamander

Monsters of the Sea