“TOO BIG TOO FAIL”

EVAGELIA TSANTILA33996919/02/2010

Topic B: Too-big-too-fail

Some weeks ago the president of the US, Barack Obama, announced that he wants to reform the financial

sector by limiting the scope and size of financial institutions .In response there has been a lot of

discussion in the financial press whether this is a good idea or not. The Dutch finance minister Wouter

Bos and the French president Sarkozy reacted enthusiastically, while the British Treasury was more

negative. What do you think about the plans of the Obama administration to restrict the size and scope of

financial institutions? Explain carefully why you think the plans are a good or a bad idea. Also discuss

why risk-taking behavior of banks is related to the size of a bank.

While the world economy still faces various threats and is trying to reborn

from its ashes, President Obama announced his new restrictions on size and scope

of financial institutions. Analytically, he imposed limitations on the size of financial

institutions in relation to their sector and banned the acquisition of hedge or

private equity funds for their own profits.

In my perspective, these measurements are fair and they will help the

American economy to move on. Obama’s chief goal is to prohibit proprietary

trading of financial securities by commercial banks using deposits in their

commercial banking sectors. By sponsoring hedge funds banks earn huge profits

and they will keep making these risky bets because they have deposits beside

them. The worst thing is that they are really big that in case of bankruptcy, could

lead at a bankruptcy of the total financial system. In order to avoid this fact the

implementation of the restrictions is really important. Otherwise, the financial

giants will be continuing operate in two fronts. On the one hand, they are

commercial banks, taking deposits, making standard loans and managing the

nation’s payment system, while on the other hand, they still trade securities for

their own accounts, without care about the financial, social and world equilibrium.

Unfortunately, without the evaluation and implementation of these

measurements, it would be possible to create again big losses by the trading of

risky securities, as happened in the latest economic crisis in 2008. As much as I

can understand, the basic objective is to control only a handful of large bank,

these which are –too big to fail- and they are not so many, among them is

Citigroup , Bank of America, JPMorgan Chase, Wells Fargo and Goldman Sachs.

It’s really feasible to support these limitations, because they are the

expected consequences at those organizations, which caused enormous damages

both to government as to households. Although, the importance is that nobody

tries to break up them or to limit their activities, it’s just an effort to limit the kinds

of risks that they can take. Hence, the new approach impose the essential action

for building again the trust between banks, investors , firms, households and

governance, meaning that , commercial banks would no longer be allowed to

engage in proprietary trading, using customers’ deposits and borrowed money to

carry out these trades.

Furthermore, Obama has also concentrated at the size of the financial

institution and he proposes to “place broader limits on the excessive growth of the

market share of liabilities at the largest financial firms”. As it’ s known, large

banks have used their diversification advantage over small banks to operate with

lower capital ratios and pursue riskier activities, but generally not to operate at

lower levels of overall risk. This pattern indicates the behavior of banks involved

in today's merger wave. Hence, if nothing changes, it would be impossible for

anyone, because of their size, to reduce bank’s risk. So, in that case, the riskier

activities pursued by large banks are profitable on average and then growth via

mergers will increase. This is the evidence why the –too big to fail- institutions

have to be broken up. All the financial institutions, in case of things go wrong, they

would not hesitate to use again and again the taxpayer’s money. From the other

part, banks say that they need to be big to compete globally and be innovative to

the benefit of the public. But that’s not true, because as far as I can see, they

always use their services for maximizing their own benefits and every time they

make double bets and they take as much risk as possible.

At this point, it’s really important to refer the significance of proposing

lower regulatory capital charges for large banks, something that is not present in

these rules. In my opinion, this fact is really necessary in order to increase the

lending, by charging less for loans and also paying more for the deposits. This

situation will help to encourage the financial services and more importantly the

consolidation in both national and global markets. Although, the measurements of

Obama’s administration will be helpful for the economy, it’s doubtful if they will be

implemented precisely by the large institutions.

Finally, as it mentioned, Obamas’ restrictions are in the right direction, and

they will probably ensure the financial stability of the economy. In the past, the

quality was strongly associated with the size of banks but now is viewed in a

different light. Having observed the collapse of “big” banks during the credit crisis

seems for many investors to be questioning whether these too big to fail banks are

simply too big to survive. As for the scope of financial institutions, the limitation of

the proprietary trading and the ban to invest in any subprime obligation is the only

way that can leads the economy at a sufficient, successful and international

economic growth.