Here is an interesting article on recent financial market troubles concerning Citi that looks at a curious situation where we have banks that are not only too big to fail but also, at the same time, too big to succeed. The article suggests that by not allowing nine major financial institutions to fail (probably quite rightly, as the cost of that failure would have been unacceptably high for the whole society), the US government may have doomed them to a kind of a zombie existance.
Citi supposedly has a plan to split itself in two – to a “good bank” and a “bad bank”, kind of a “spirit” and “corpse”. Only that the corpse is really not dead – otherwise they might just write that stuff off, instead of creating another, lesser zombie. This is a kind of a financial voodoo that Paul Krugman is rightly sceptical about – after all what we have been through over last half a year or so we, amazingly, still seem to have plenty of people who think that it would be a good idea to try and structure ourselves out of the present mess, that some potent financial magic can still create value out of nothing – if we only get it right this time.
I actually think that the split is a good idea, in fact it is in all likelihood inevitable – but not along the lines of good and bad assets. The financial system that we have now has grown out of something that was intended to solve a radically different problem. Initially the banks were meant to serve the needs of business (and an odd monarchy) – to extend loans, manage financial assets that were not immediately needed, process transactions, provide insurance and certainty in trade finance, etc. This was, by and large, true all the way from 15th century to up until some fifty years ago. It was in connection with the rise of a relatively wealthy middle class that the banking gradually went retail on any significant scale.
This, however, created a new and very different situation. No more was the banking system simply an expendable service provider – it slowly became a part of the infrastructure that we rely on in leading our everyday lives, a utility just like those that provide us with electricity, drinking water, or transportation. Unlike what is usual with utility companies, banking system was not a government-run or -regulated monopoly anywhere in the West, rather than a competitive industry with several providers. That was supposed to give us assurance that not only is the cost of service as low as possible (which of course is very much doubtful and has been also challenged both in case of banks and credit card companies) but also that we’re shielded from the failure of any single provider.
What we weren’t shielded from, of course, was the case where all the providers failed together. However, this is pretty much what has happened now and as they collectively form a crucial part of our everyday infrastructure, governments all across the world simply can’t let them. This of course creates a thorny situation that has often been referred to and that was recently ironically summed up by Mikhail Gorbachev as “Communism for the rich and capitalism for the poor”.
So, this would lead one to think that if the financial system, or at least a part of it, is of such fundamental importance to a society it would be quite justified to treat it in a similar way to a water utility, a railway or a national energy company. But those are not merely regulated – they are pretty much government controlled, if not owned and operated. This obviously also has its downsides – but we’re happy to live knowing that there is not as much innovation going on in our utility companies as there might be would they be traditional competitive industries, as long as we know that they are around, good times or bad.