Investment Banks and Too Big Too Fail: Bigger Than Before

Too big too fail. Any student of finance has heard about this moral hazard issue described by such cases as Long-Term Capital Management. Such was the motif during the bailouts of 2008 when former Treasury Secretary Henry Paulson single-handedly rescued the American financial system.

Despite its supposed necessity, the latest Pew Research poll shows that 52% of respondents still think it was wrong to grant the financial bailouts. At that time the assets of the top five bank holding companies (BHC) JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs was 43% of U.S gross domestic product (GDP). If only that were the case today, these firms are now far beyond “too big too fail”.

They are fully integrated institutions of the entire world financial system rivaling smaller nations of the world. The same five BHC total assets as of December 31, 2011 now comprise more than the entire GDP of South Korea, Mexico, Australia, Spain, Russia, and India combined in U.S dollar terms, totaling over $8,900 billion!

In contrast to today’s banking concentration, 28 years ago there existed more than twice the current amount of commercial banks. However, according to Wilbur Ross, Chairman of WL Ross & Co. now some

…90-odd percent of small banks are under $1.5 billion on deposits are pretty much an obsolete phenomenon.”

Given a statement like this it seems that our current model of so-called capitalism has largely driven competition out of the banking industry and realistically into an oligopolistic system. As such, are we as a country increasing our systemic risk by continually concentrating financial power in the event of another widespread market anomaly?

Certainly, the federal government has assisted them in asserting their dominance in this regard. Some example activities include the rigorous lobbying efforts by FIRE, the actions of Citigroup in coalescing the Gramm-Leach-Bliley Act, and possibly numerous private Treasury and Federal Reserve transactions. Further, Standard & Poors and Moody’s Investors Services anticipate that the U.S government would rescue large banks in the event of another future crisis.

In addition, Kevin Warsh, former member of the Federal Reserve Board of Governors states:

Markets have come to believe that what the government did in 2008 and 2009 isn’t a one-time deal, that the government will somehow come to the rescue of these big financial firms.

Sources: Bloomberg and Neal Boortz, April 2012

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