Why "too big to fail" must end forever

By John Kay of the FT:

There are people who believe that, in future, better regulation, co-ordinated both domestically and internationally, will prevent such failures. The interests of consumers and the needs of the financial economy will be protected by such co-ordinated intervention, and there will never again be major calls on the public purse. There are also people who believe that pigs might fly. Mervyn King, governor of the Bank of England has made enemies by pointing out that they will not.

It is impossible for regulators to prevent business failure, and undesirable to pursue that objective. The essential dynamic of the market economy is that good businesses succeed and bad ones do not. There is a sense in which the bankruptcy of Lehman was a triumph of capitalism, not a failure. It was badly run, it employed greedy and overpaid individuals, and the services it provided were of marginal social value at best. It took risks that did not come off and went bust. That is how the market economy works.

The problem now is how to have greater stability while extricating ourselves from the “too big to fail” commitment, and taking a realistic view of the limits of regulation. “Too big to fail” exposes taxpayers to unlimited, uncontrolled liabilities. The moral hazard problem is not just that risk-taking within institutions that are too big to fail is encouraged but that private risk-monitoring of those institutions is discouraged.
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When the next crisis hits, and it will, that frustrated public is likely to turn, not just on politicians who have been negligently lavish with public funds, or on bankers, but on the market system. What is at stake now may not just be the future of finance, but the future of capitalism.

The latest installment in outsourced economic criticism in these difficult times.