Unintended Consequences

The concept of “too big to fail” banks is not new.    The concept was that there are a handful of banks in New York that would have catastrophic consequences if they fail, because so they hold so much money and are so integrated into the complete banking system could fail.   As a result, they have been quasi-nationalized banks all along.

For example, CitiGroup is a large operator in what is called Treasury and Cash management services for huge corporations.   Large companies like Wal*Mart have an extremely high velocity of money – when you buy something with a credit/debit card, by the time you’re at the door, the money is already gone from your account and on its way to pay suppliers ot pay for more inventory in the pipeline.  When currency is deposited by the store in a local bank, it is “swept” into a central cash management system at least once a day.   (Stores like to do cash advances because that converts the currency into immediate cash liquidity instead of having to wait for the armored truck to show up). 

If CitiGroup’s operations stopped – even if the customers didn’t ulutimately lose any money, the day to to day operations of their business has become completely integrated with CitiGroup’s cash management system.    By the time they could switch to some other equally large bank offering similar services, the entire inventory and cash flow and payroll processing could be disrupted.   

The Federal Government has encouraged this type of concentrated banking in a few hands by declaring that certain banks are “too big to fail”, and hence this is no risk to having all your corporate eggs in their basket.  Keep in mind that FDIC coverage is capped at $250k even for corporations – so FDIC protection is very limited for corporations.

Single points of failure are a really bad thing.  If you are concerned about survivability, when you become aware of single point of failure, you get rid of them – or if it can’t be gotten written of you take steps to minimize the damage from a failure.   The obvious solution is contained in the name.  If the problem is that a bank is “too big to fail”, you take steps to make the bank smaller and/or keep its hands out of the things likely to cause a failure.  Rather than promoting more and more consolidation into fewer and fewer huge global banks, a thoughtful “intelligent” policy at the U.S. Treasury would strive to dismantle the “too big to fail” banks, or at least break out the functions that are critical to national economic security from the portions of the big banks that might trigger a failure.   Bringing back something like Glass Stegall would be a large step in the direction, although it might be a bit like unscrambling an egg at this point.