If you’ve ever raised a risk-taking teenager, you know the promise of swift and certain consequences is about the only tool you have to prevent misbehavior.
There are two kinds of consequences: those that occur naturally, such as wrecking the car when driving too fast, and those that are imposed, such as being grounded for a month.
So it is with regulating banks and financial institutions. There are the natural consequences of bad behavior: collapse, and loss of pay, employment and prestige. And there are the consequences imposed by the government, such as liquidation, fines or even jail.
In good times, Wall Street says it wants to live or die by the market, not regulations. Democrats in Congress are looking at tighter controls or even splitting up the biggest institutions so they don’t combine commercial banking and investment banking.
But when people talk about an institution being “too big to fail,” then you are changing the rules for everybody. The big banks are immunized from the consequences of their actions, no matter how risky, and the smaller banks are penalized with higher costs of doing business just because they could fail, even through no fault of their own.
In the current crisis, some firms were allowed to fail, while others were protected because of the fear their collapse would bring down the global financial system. They were propped up with cash, cheap credit and, most importantly, the ultimate government guarantee of TBTF: “Too Big To Fail.”
Ironically, the financial companies that were not allowed to fail are now bigger than before the crisis, and therefore even more protected by Washington.
We are unlikely to go back to the old regulations imposed after the stock-market crash that occurred 80 years ago this week. But look for the Obama administration and Democrats in Congress to try to make failure possible, without wrecking the system.