Dealing with Institutional Failure
From Zanecorpwiki
On 12-15-09, George Schultz gave an interview with the PBS News Hour in which he described a very simple solution for dealing with "too big to fail". Simply wire the institutions in parallel. The metaphor uses the old style serial Christmas lights, which were wired in series. If one light on the string went out, all the lights went out. Even worse, finding the bad light was a guessing game and the longer the string, the longer it took to fix.
Modern lights are wired in parallel. It's a little more complicated in the actual wiring, but now problems with one light don't effect any of the others. Even more important, it's obvious which light is the problem (it's the one that burned out) and fixing it is easy.
For financial institutions the lesson is simple. You can do whatever you want, just isolate your operations. The problem isn't risky investing, it's risky investing under the same roof with regular deposits and traditional low risk loans. Simply house the risky operations under a separate entity and make it clear that the banking operations are separate. Those investing on the risky side cannot expect to dip into the banking operations for a payback.
Since the depression until the late 90's and early 00's when the rules for this kind of thing were relaxed.[notes 1] Greed took over and banks dipped into their secure deposits in order to make as much money as possible. They knew it would fall apart (or they were idiots), but also knew that the government would step in and save them. The (bad) banks abused us, with absolute intention (or again, they were run by morons. But we let it happen (or rather, representatives beholden to lobbyists let it happen and we didn't hold the representatives accountable).
In other words, the solution to our problem is the solution that we always had and got rid of. There's absolutely no mystery about any of this.
Notes
- ↑ This is all me talking now. It is true that it was time to revisit the rules, and it would have made a lot of sense to restructure the restrictions to allow more freedom, but it could have easily been done in a way that sheltered traditional banking operations from excessive risk. Of course, the goal was explicitly to leverage low risk deposits into high risk returns with a guaranteed bailout at the end, so rational changes weren't really on the table.
