During his appearance on Capitol Hill this morning, Tim Geithner was asked by Elizabeth Warren about the bank/auto double standard. Why have auto companies been forced to change executives, while threatened with bankruptcy on a firm deadline?
Banks on the other hand get treated like a piece of fine crystal — gingerly and tenderly with relatively little pressure.
Come on, Elizabeth. This isn’t that hard. Sure, we can pretend there’s some inexplicable double standard or that the government is captured by Wall Street or that the Treasury doesn’t care as much about what happens to companies in the industrial midwest. But that’s not what this is all about.
We treat banks gingerly because, well, they’re naturally fragile. Even the healthiest bank imaginable is inherently fragile. The best capitalised bank in the world that only made loans to the healthiest borrowers imaginable could go bankrupt overnight in a panic. That’s just the nature of the banking system.
There are steps we could take so that this wouldn’t be an issue. We could eliminate fractional reserve banking. Or maybe we could cap the balance sheet of any bank at $50 billion so that no bank could ever be systemically important.
But since that’s not the situation we have, regulators have no choice but to take a light-touch approach to these things. It’s easy to advocate for the extreme response — no more bailouts, can all the execs, wipe out lenders, etc. — but the risk is in starting a major panic and making the problem much worse.
That’s why we’ve suggested that the emphasis of future regulations be to prevent any institution from becoming too big to fail — or to put it another way, to make it so that institutional failure is ok. But that’s not the direction we seem to be going, therefore we’ll always get policy reactions that don’t live up to our strict ideas of what’s right and wrong.
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