"Too Big to Fail" Assures Bigness - and Failure Guest post by Tom Evslin

This article was originally posted on Tom's blog, Fractals of Change, on 11/15/11

Reader Bobsv57 asks:

"Tom, a question for you. I am under the impression that most, if not all, of the money used to bail out banks has been paid back with interest and it is actually the money used to bail out GM that hasn't been returned. Am I correct in this observation? and if I am, then why to you make the statement calling for no more bank bailouts? (Not that I particularly support them in any case) It would seem that the bail out was a money maker for the Fed, wasn't the interest they charged the banks for TARP funds greater than the interest the Fed pays on it's national debt?"

Bob is right that the banks paid back their loans with interest. But the eventual cost of the bailout is likely to be the failure of our banking system and massively increased public debt. Meanwhile, middle America is starved for credit while the "too big to fail" banks are getting bigger at the expense of their better managed smaller and safer brethren.

An article in the Wall Street Journal explains one way that corporations are positioning themselves for the next credit crisis:

Three Scenarios for the Economy (and the Stock Market)

Which way are the economy and stock market going to go? Up? -- or down. And, how far? Since the future is unknowable, rather than planning for a single future, strategic planners find it useful to develop multiple scenarios. Typically, one develops 3-5 scenarios covering a wide range of possible futures. In this post, I outline (literally) three scenarios that I think are representative of the range of possible outcomes of the current financial/economic crisis. They range from “Business as Usual,” the best-case scenario, to “Snowball,” the worst-case scenario. The “descriptions” help me to visualize a future environment so that I can conceptualize plans suitable for that scenario.

I apologize for the lack of prose, but the outline form may be clearer. Equally importantly, I don’t have time to make it "flowery." Note that these are preliminary descriptions and I may update them periodically.

Business As Usual Scenario

It’s always helpful to have a “status quo” scenario; this is also my best-case scenario. In essence it says this economic “crisis” will turn out to be

The Crisis: A Contributing Factor

As a result of the current financial crisis, there is a growing consensus that the government “dropped the ball.” (See, for example, Michael Grynbaum’s article in the October 24 New York Times.) In other words, the government itself is one of the causes of the crisis it is now attempting to resolve. In particular, the accusers argue, the government is at fault because it did not provide adequate oversight of our financial system. Generally overlooked are more subtle contributions to the current economic crisis, and to the associated stock market crash – some government “sponsored”, some not.

What do the following developments of the last half-century or so have in common?
1. Mutual funds
2. Modern portfolio theory and index funds
3. Deregulation of the stock brokerage industry
4. No-load mutual funds
5. Tax sheltered accounts (e.g., IRAs)

Each of the above was hailed, at least to some extent, as giving the general public broader access to the potential riches of the stock market. Largely because of these developments, over the last 50 years the public’s participation in the stock market has increased dramatically. Unfortunately, they have also inadvertently combined to engender some profound, and somewhat disturbing, changes

Sobering Comment

Today was still another terrible day for the stock market – and especially for General Motors. More than once, I heard a commentator say, “GM is fighting for its life.” That statement was especially poignant for me, and I expect for others of my generation who will never forget the old adage “As GM goes, so goes the nation.”

Hmmm....

Wall Street Bailout, or Main Street Rescue?

I was surprised Monday to hear that the House of Representatives rejected the “bailout” bill. The 777 point decline in the Dow suggests a few other people were surprised as well. On balance, I was in favor of the bill. How could 228 smart representatives disagree? What were these representatives thinking? As best I can tell, their reasons for voting against the bill fell into two broad categories, philosophical and political.

Philosophical Reasons for Voting Against the “Bailout “

The philosophical arguments against the bill seem to be based loosely on the belief that “bailing out Wall Street” somehow goes against the basic tenets of capitalism. Many people believe strongly that poorly run companies should be allowed to fail. Similarly, the “moral hazard” argument argues that those who have made poor decisions should suffer the consequences of those decisions.

Much of the economic theory that we think of as the “basic tenets” of capitalism is based on the concept of

The Fed Proposes Insurance for Money Market Funds

This is clearly an historic period in global financial market history. Virtually anyone with a substantial portion of his portfolio in equities has taken a hit. One thing that has allowed me to sleep nights is having gone through a few bear markets before. However, almost no one alive has ever experienced markets like these. Perhaps the most important reason I have been able to sleep nights is that about half my portfolio is not in the stock market. I invest the “safe side” of my portfolio primarily in government bonds, and government insured certificates of deposit – and money market funds. Yesterday, I sold the money market funds.

Under normal circumstances, money market funds are safe. They buy short-term debt instruments, including commercial paper (short-term loans to businesses). In the history of these funds, almost no one has lost money by investing in them. However,