Tuesday, December 8, 2009

Too Big To Fail - contd.

I have commented earlier on the TBTF doctrine.

Recently, I came across a couple of other references on the TBTF situation and what to do about it. The first from the FT has the author Willem Buiter presenting a slew of solutions on what to do about banks becoming TBTF. (Interesting how this abbreviation seems to have taken on a life of its own!) Definitely worth taking a more detailed read as the author goes to a fair degree of detail on what are some of the probable solutions.

The second is a novel way of valuing the benefit that banks get from becoming TBTF. The approach (proposed by a couple of economists Elijah Brewer and Julapa Jagtiani from the Philadelphia Fed) argues that the measure of the benefit that banks expected to get could be ascertained by the acquisition premium paid by these very banks along their journey to becoming TBTF. The estimate of this premium (looking at acquisitions from 1991 to 2004) is about $14 billion. This link references the actual paper written by the economists.

Given my obsession on getting to an optimal risk management framework for financial institutions, I thought I'd share a couple of these links.


Anonymous said...

The recent flare-up about bank bonuses and Goldman Sachs in particular has shown how the populist changes are gathering more momentum than the more important systemic changes. Probably because the populist changes are the hot button issues that get the public and the political class riled up.

TBTF is not an easy problem to solve, like healthcare. But it needs to be done for a stable financial system going forward. The next such big crash could claim a bigger casualty than Iceland.

Don said...

The financial system was put under peril because there was no way of letting big firms fail safely.

Let us not confuse this with a problem in getting firms to be too big. The financial system needs the backstops (Fed? Are you listening?) to stop systemic collapse. At the same time, the system needs to create the free market that will allow firms to grow to a size that is optimal for its shareholders.