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Too-big-to-fail

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grant.w.underwood Posted: Sat, Nov 17 2012 1:29 AM

So I'm doing a little Friday night studying for school.  Here is the paragragh quoted from my book (personally written by my professor) to discuss.

Could the world afford a failure of a trillion-dollar banking empire?  The ripple effect upon other financial institutions and financial markets could be devastating.  Among the possible consequences of such an event would or could be: (1) cessation of trading in all financial instruments because of a freeze-up of markets and an unwillingness to trade; (2) immediate bankruptcy of numerous inter-connected institutions; (3) inability to settle transactions among institutions; (4) significant increases in market interest rates.  The obvious answer to the question posed above is no.

ITS OBVIOUS PEOPLE! HAHA.  of course he doesn't answer the question he just says that is obviously true.

I think anyone that reads AE can knows the rebuttal to consequence 4.  So im not concerned with that.

 

I would like to know rebuttals to 1-3.  I agree that there would be a huge impact in trading and that there would be a freeze-up (which i dont think anyone would disagree, though if you do i'd like to hear why).  I know the harms that will come from government intervention (so i want to avoid discussions of intervention).  I'm more concerned with market response and actions that the banks will take without intervention.  Like what would say if you were in the room with the President, big ben, us treasury, and whoever else to prove that you have to allow the banks to fail.

Has there ever been a trillion or a multi-trillion dollar company that failed (adjusting for inflation)?

whats to happen to the deposits on demand of the customers if banks start failing left and right? 

or does someone have a well formulated response that does not involve a dependancy on just trusting the free market to fix it (i know this is true, but for arguement sake with a former Fed employee he won't buy it)

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Neodoxy replied on Sat, Nov 17 2012 3:08 AM

I think that it's pretty true. The fact is that fractional reserve banking relies upon itself and relies upon confidence in the system itself. If you allow these massive banks to fail then you allow the system to fall down upon itself. Why would this not be the case? A huge lesson of Austrian monetary work is that fractional reserve system is utterly unstable.

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... sounds like you are making a case to bailout the banks

 

So your Austrian defense would just prove the instability of fractional reserve banking?

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Neodoxy replied on Sat, Nov 17 2012 4:04 AM

Of course it does.

In what sensible system do we have to spend a trillion dollars to save a system which just failed? In what other industry does the failure of one company, even a major one, mean the collapse of the entire system? That's the opposite of what capitalism is supposed to be doing which is weeding out unwise entrepreneurs.

I actually think that your quote understates the significance of a banking collapse. The loan market is the backbone of the market system.

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Justin replied on Sun, Nov 18 2012 8:36 AM

As Neodoxy pointed out, within the context of fractional reserve banking, big banks really are too big too fail.

What if the government propossed to break up the big banks into dozens of smaller banks, so that no bank controlled more than, say, $100 billion? Obviously such an intervention into the market would be a horrendously unlibertarian thing to do, and it is yet another example of government meddling causing problems that then 'require' more meddling.

But would such an intervention be preferabble to more trillion dollar bailouts? Knowing that abolishing the Fed and fractional reserve banking is unlikely to say the least, would such a bandaid be more aceptable than the (realistic) alternatives?

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z1235 replied on Sun, Nov 18 2012 10:04 AM

grant.w.underwood:

whats to happen to the deposits on demand of the customers if banks start failing left and right? 

This is the crucial part. Through fractional reserves and legal tender laws, gov+banking cartels are holding whole societies (depositors, taxpayers) hostage. I like to explain this with the following analogy: Imagine that someone is hanging over a cliff while tightly holding you by your balls. You have been placed before two very painful choices: (1) pull him up or (2) cut off your balls. The problem occured way before, when you allowed this entity to have you by the balls in the first place -- not when he inevitably went over the cliff. 

So, given your awful predicament, you may be better off with option (1), i.e. bailout, but you may want to think about who's still having you by your balls going forward. This is where abolishing legal tender laws and capital gains taxes -- eliminating the money monopoly -- comes in. 

In a free society any entity of any size is free to fail bringing only its owners (shareholders) and creditors down with it. My sound money would be resting quietly deposited in a sound institution. I -- and other sound entities -- may decide to "bail out" the failing entity only if we expect to be rewarded handsomely for taking the risk. 

 

 

 

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Groucho replied on Sun, Nov 18 2012 2:02 PM

(1) cessation of trading in all financial instruments because of a freeze-up of markets and an unwillingness to trade; (2) immediate bankruptcy of numerous inter-connected institutions; (3) inability to settle transactions among institutions; (4) significant increases in market interest rates.

All catastrophic risks that are brought on by enabling fractional reserve banking in the first place. It's an evil system that makes slaves out of all of us in order to support its continued existence.

And it's worth mentioning that these things, along with hyperinflation, will all eventually happen anyway and made all the worse by the faustian bargains we've implemented along the way to postpone the inevitable.

An idealist is one who, on noticing that roses smell better than a cabbage, concludes that it will also make better soup. -H.L. Mencken
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