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Greenspan on "Too Big to Fail"--Skeel

            I was a minor player in a very interesting conference on systemic risk yesterday at the American Enterprise Institute in Washington DC yesterday. In the keynote address, Alan Greenspan suggested that he sees only three plausible responses to the emergence of financial institutions that are “too big to fail,” and thus will be bailed out if they fail. The first is to impose higher capital requirements on bigger institutions—in effect, to require them to have more equity and less debt on their balance sheets, so that they are less likely to fail. The second is for people to start new more new banks. Since new banks won’t have the baggage of the banks that are still holding lots of “toxic” assets, they presumably would be well positioned to compete with the big current banks. Third, he suggested that lawmakers might require that investment banks be structured as partnerships rather than corporations, as they were until recently. Because the partners of a partnership are personally responsible for its debts if it fails, the folks running future banks like Bear Stearns and Lehman Brothers might take a lot fewer risks. 

            The proposal to impose strict capital requirements on institutions that are “too big to fail” is a good idea, in my view, but it’s conventional wisdom (and is already on the administration’s radar screen). Forcing investment banks to be structured as partnerships is a very interesting idea but, as Greenspan himself noted, would almost certainly be evaded (for example, commercial banks could simply step up their involvement in investment banking activities.
            But I wonder whether we’ll set entrepreneurs taking the second idea to heart in the next year or two. As bad as the economic climate is, now might be a great time to start a bank, for those who have the inclination and the expertise.


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