Tuesday, March 17, 2009

Unintended consequences of "Too Big to Fail" and other possible changes in regulation

Unintended consequences.

People mean well (yes even politicians and regulators) when they clamor for new rules and regulations to solve this crisis or that. But what they often fail to realize is that their actions have unintended consequences. For instance, from the Wall Street Journal seemingly in response to Bernanke's recent comments that some institutions are too big (important) to fail.:

Congress Is the Real Systemic Risk - WSJ.com:
"A company that is designated as systemically significant will inevitably come to be viewed as having government backing. After all, the designation occurs because some government agency believes that the failure of a particular institution will have a highly adverse effect on the rest of the financial system. Accordingly, designation as a systemically significant company will in effect be a government declaration that that company is too big to fail.....As a consequence, the effect on competition will be profound. Financial institutions that are not large enough to be designated as systemically significant will gradually lose out in the marketplace to the larger companies that are perceived to have government backing, just as Fannie and Freddie were able to drive banks and others from the secondary market for prime middle-class mortgages. A small group of government-backed financial institutions will thus come to dominate all sectors of finance in the U.S."


Highgamma said...

And shouldn't economists who advocate government policies be forced to take into account these "unintended" consequences when they make their proposals?

David said...

Possibly 'too big to fail = too big' might be another factor anti-trust regulators take into account.