Punishing Banks Won’t Work

The best defense against bank failures isn’t regulation, rather the threat of bankruptcy.

We’re not the only ones opposing President Obama’s recently announced Financial Crisis Responsibility Fee, the new tax on “big” Wall Street banks that is to pay for the billions of dollars thrust into the financial system by the American government since the recession begun.

Where we argued against the morality of the tax, Nicole Gelinas, author of After the Fall: Saving Capitalism from Wall Street — and Washington (2009) explains in the New York Post why it won’t work.

The administration is trying to address public outrage over bankers’ bonuses but people aren’t just upset over the money that’s being made on Wall Street. “They’re angry,” writes Gelinas, that the bonuses are “going to people at firms that got bailed out last year as ‘too big to fail’.”

In other words, the public’s angry that the government’s made the financial industry immune from consistent market discipline. Small businesses go under if their owners make catastrophic mistakes — but shareholders of failed insurer AIG live to see another day.

“The popular impulse is right,” says Gelinas. The financial sector must realize that bankruptcies will happen when warranted. That, she notes, is the best defense against bank failures — not more regulation. Indeed, the “too-big-to-fail fee” will achieve the very opposite.

All imposing this fee will do is hammer home the idea in bondholders’ minds that the firms […] are too big to fail, that the government will bail them out again the next time they screw up.

Freeing banks from the safety net of “oversight” benefits them as well as their customers. As we noted before, “In a truly free market, failure is possible and consumers are aware of the risk — with the result that they rationally and voluntarily assume less of it.”

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Comments

  1. Intriguing observation, Nick. The Senate Select Committee on Intelligence targeted the Intelligence process post-9-11 for the failure. The idea that bad results are the fruit of bad processes may make sense politically but not intellectually. Simmilar stuff with the banks?

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