What is Too Big to Fail?
There seems to be various discussions going around about who needs to be considered Systemically important to qualify for “Special Attention” from regulators. Very large money managers are saying that they are not systemically important.
But it seems to me that there are quite a number of considerations. And everyone seems to be arguing solely from the part of that list that exempts them.
When thinking about money managers, I would think of the following:
- How is their liquidity managed? Can they really raise funds fast enough to satisfy a run on the bank?
- If they were to try to liquidate their funds, what would that do to the financial markets?
- How interconnected are they to other financial firms? Do regulators now have information about that?
- What about the future? (Isn’t that our concern, not the past or even the current situation?)
- Could they shift their liquidity practices to become much more illiquid?
- Their argument revolves around leverage, how much could they change their leverage under their current regulations? They can quickly leverage through derivatives as well as borrowing.
- Could they become the center of new risky financial behavior that would endanger the financial sector?
That last point is a major concern of regulators regarding the Insurance industry. And they have history on their side. The insurance industry helped the financial sector to blow the mortgage business up to 4 or 5 times the underlying.
All you need to do that is a big balance sheet and a willingness to take one side of a trade without balancing it with the other side. And the money managers as well as the insurance companies both have exactly those characteristics.
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