Too Big to Fail: The Underlying Cause

“We need radical change,” Lord Turner, chairman of England’s Financial Services Authority, said recently.  “And parts of the financial services industries need to reflect deeply on their role in the economy, and to recommit to a focus on their essential social and economic functions, if they are to regain public trust.”  The British are engaged in an active debate on how to make sure Too Big To Fail bailouts never happen again, and that they do away with corporate-state capitalism in which profits are privatized while losses are socialized.  In a capitalist system, the uncompromising hand of the market punishes bad decisions.

Lord Turner supports a plan to redesign the regulatory framework and revise the way the markets are supervised.

The Glass-Steagall Act, passed by the U.S. Congress in 1933, separated commercial banks (deposits and loans) from investment firms (trading and underwriting stocks).  The socially useful functions consequently do not interact with, and cannot be infected by, the gambling that modern banks seem unable to resist.  Congress and the Clinton administration repealed Glass-Steagall in 1999, and the banking system exploded nine years later.

Mervyn King, governor of the Bank of England, supports a Glass-Steagall-like separation of banks into “utilities” and “casinos.”  He would also shrink the size of the banks until...

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