The end of banks that are “too large to fail”?

July 5, 2009 – 11:56 am – No Comment

It appears as though the Obama administration is taking steps to make sure financial fiascos like the one we’re coming out of never happens again. It looks as though financial regulations proposed by the president could mean simpler and smaller banks and financial institutions. In the new system, small banks wouldn’t carry the weight of the financial system and if it failed, the only way it could be saved is if it could find help from another bank or investor.

I’m glad to hear that the government is taking steps to keep something like this from happening again, because we all know how popular bailouts were when the government started handing out tens of billions of dollars to failing banks (sarcasm doesn’t always come out the best over written word, but I think many of you know that’s what I was going for).

To avoid having to do that again, President Obama’s regulatory plan is calling for large financial companies to “pay a heavy price for the system-wide risk they pose.” Under the plan, large companies like Goldman Sachs, Citigroup, Bank of America, etc would face much stricter scrutiny and would be required to have more liquid assets as a buffer against a recession or another financial disaster like we have seen in the last year. Also, the banks would be required to anticipate and prepare for their own failure and would be required to draft very detailed descriptions of how to pick the company apart quickly without causing any harm to the overall financial system.

“Without banning them we’re providing some pretty heavy penalties for entering” the top group of institutions that could pose a risk to the entire financial system, said Diana Farrell, deputy director of the White House’s National Economic Council. “The regulator might say to a large institution, ‘Make sure there is very good reason to allow yourself to get that big, or that interconnected, or that complex because the penalties will wipe out any advantages, such as lower cost of capital, you might have.’”

There will be companies that have to just accept the new regulations and deal with them because to compete in the global capital market, some firms have to be large. I would guess that most would limit their size, however.