Recently I read an article stating that in compliance with the Dodd Frank regulation bill, banks are being sent out a questionnaire to determine if they are “systemically important.” Let me jump to conclusions here, and state that “systemically important” seems to be a euphemism for “too big to fail.”
I can foresee a few problems here. The first is that the whole concept is flawed. As my friend, economist Yuri Maltsev says, “There is no such thing as TBTF-Too Big Too Fail” in his discussion of the bank bailouts of the recent past. “What we really have with these institutions is TBNTF-Too Big NOT to Fail.”¬¬¬
A second problem is that “systemically important¬¬¬ may be decided politically, just as saving the auto companies was more to preserve the votes of union employees than any economic consideration. My guess is that firms “systemically important” to the Democrat Party and Obama are likely to be preferred over others.
And a third is that protecting certain “systemically important” firms may create a moral hazard, where these firms are more protected, and hence take more risks than firms without that designation. This is likely to mean more bailouts for the worst run firms.
A fourth problem is that Dodd Frank loads the financial services industry with paperwork in an attempt to eliminate or minimize risk. This is a fool’s errand, as there will always be risk in investments. Further, this paperwork adds tremendously to the cost, and induces firms to take fewer risks, which will mean fewer opportunities for borrowers. In particular, smaller banks are finding this harder to deal with, and again, many smaller banks did not take the risks that bigger banks did, but are being disproportionately discriminated against by the paperwork burden. Expect more smaller banks to fail, as they can not afford any but the most sound investments lest they run afoul of the law.
Finally there is likely no saving firms, even financial firms that are not economically sound. The better thing in the long run if not the short would be to let the market work, liquidating the unsound and clearing the market of malinvested capital, so that in the long run the economy is more sound. The great irony is that in the name of security, Dodd Frank has eliminated much opportunity and put an entire industry at risk and the US economy at greater risk than if it had not been written at all.