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Jun 7, 2012

TBTF is TBTI

With the euro-rollercoaster going for another ride, Spain’s banking sector on the verge of collapse and the solvency of states decreasing by the day, I wonder whether the lack of foresighted regulation of the banking conglomerates is coming back as a boomerang. Not, in this case, in the face of the taxpayer directly but in the face of the investors.

The issue of ‘too big to fail’, which as many have rightly argued may not only lead to socialising the losses but also gives an unfair advantage to large banks because of governments’ ‘underwriting’ their risk portfolios (see the baseline scenario, for example), now seems to also have become ‘too big to invest’. The lender of last resort, the world’s states, after all, has fallen of its solvency pedestal. If it saves a ‘too big to fail’ it may just go from bad to worse.

When investors, financiers and the like distrust the lender of last resort, because it is hardly able to pay off its own debts, let alone handle the burden of having to save a failing bank, what about trusting the banking conglomerates? Not only as a ‘sound’ investment, but also as a safe haven for parking excess deposits? (Of which they have received a tremendous amount over the last couple of years; paradoxically skewing the balance of inflated banks vis-à-vis the state.) This, of course, is not the only aspect negatively influencing expectations about future returns. But there is a stark underlying contagion risk that finds its origins in large cross-border financial institutes that can only fall back on certain 'sovereign' entities as their theoretical lender of last resort. An unsustainable situation, if you would ask me.

But with the boomerang approaching fast, it may bring some good, too. So far pressure to tackle ‘too big to fail’ has mainly focused on the protection of taxpayers. Finance and businesses have stayed silent, because they did not want to upset the banking behemoths or were in for a free ride – well, one underwritten by the taxpayer. But now they may realise that there is no such thing as a free ride, with their business models increasingly jeopardised due to the exposure of a patchy system. Maybe they will even pressure governments to break up big banks! Too utopian a thought? Or will our next stop be a carousel instead of a rollercoaster?