Part 1: Defending the idea of implementing regulations to avoid or limit the consequences of too big to fail During the financial crisis of 2007-2008 too big to fail was a major problem for some economist. They believed that size limit could have prevented the financial crisis, researchers suggested that the government could also raise the cost of providing banking services, this will prevent big banks from exploiting economies of scale. A production process is considered economies of scale if the cost of producing one unit of output falls with the increase in the amount produced. Bankers often use economies of scale to justify mergers and acquisitions. Treating the banks as too big to fail generated economies of scale by lowering the …show more content…
Banking is one of the most regulated industries, risk management is the most important aspect. More specifically, risk management techniques that reduce volatility i.e hedging risk. Before the crisis, value added of derivatives was necessary for the process of wealth creation. Higher use of derivatives corresponds to greater systematic risk, there is a positive relationship between the derivatives and risk in trading as well as hedging. The figures below shows that this positive relationship is stronger for the large business holding companies (BHC) than for small BHC. This indicates that the large BCH with operations in brokerage, asset management and trading primarily uses derivatives to derive their gains further exposing them to systematic risk. The small BCH results indicate that they use derivative to a larger extent to hedge against the systematic risk. Policy implications was imperative, caution was needed regarding the BHCs’ involvement in derivatives business, and limiting the use of these derivatives. Regulations aimed to separate commercial banks from risky banking activities. The regulators wanted to reverse the positive relationship between derivatives and systematic risk, at the same time they wanted to maintain the bank’s efficiency. Part 2: Opposing the idea of implementing regulations to avoid or limit the consequences of too big to fail The financial crisis of 2007-2008 revealed the connection between
The banking industry has undergone major upheaval in recent years, largely due to the lingering recessionary environment and increased regulatory environment. Many banks have failed in the face of such tough environmental conditions. These conditions
Some challenge that the most efficient regulator is free-market competition among those seeking to attract the buying public. They argue that government regulation is intrusive with the marketplace and works to the disadvantage of both consumers and producers. Advocates of government regulation, however, see a better need to observe and guide the path of competition. They believe that an entirely unrestrained market will unavoidably lead to monopolistic practices, higher costs, underserved segments of society, and lower-quality goods and
Even though the federal government is the main source of promotion and regulation of industry in America, regulation almost inescapably obstructs success
Assessing and quantifying these types of behavioral reactions regarding the economic consequences of a proposed standard will always pose difficulties for the FASB, “There is no way of determining optimal regulatory policies that maximize the social welfare or the public interest. The best that regulators can do is to try to determine that a net benefit exists-that is, an excess of benefits over costs.” (Wolk et al p 129)
This also means that our political leaders that should be concerned about the effects of regulation. In my opinion, there advantages and disadvantages to regulation. The advantages are the Government should be regulating certain things to make life safer and to make America stronger, and better place to live. The disadvantages are, the government should be regulating with more common sense. What I'm saying is the government should consider the costs and the benefits of what they're regulating. Unfortunately, if the Government does not, Americans run the risk of some kind of regulation that can't be explained by anyone except a bunch of lawyers which is going to cost the taxpayers more
However, current president, Donald Trump, has urged a push back to the laissez-faire economic philosophy of Adam Smith. In a meeting with multiple executives of large American companies, President Trump explained, “cuts to both corporate taxes and regulations — promises he made for the duration of his campaign — were on the horizon” (Lam, 2017). The differing economic philosophies presented in the stimulus material and the new president’s ideas for the future of the american economy, led me to ask the research question, “Should the United States federal government increase economic regulation?” By first examining a historical lens on the effects of economic regulation, then a scientific lens on the effects regulation has on innovation in science, and finally, an economic lens to look at the overall effects of President Trump’s plans to decrease government regulation, it will be clear the United States federal government should not increase economic
According to Randall ‘too big to fail,’ (TBTF) policy is legal reorganization of the fragile bank so that uninsured creditors and Federal Deposit Insurance Corporation could be saved from suffering a loss. In addition, Randall argues it is necessary to extend the TBTF policy to all depositors and creditors of larger banks to avoid the situation of a failure of such banks will lead to failure of other banks. Randall argues that the federal safety net should be limited only to banking institutions and should not enlarge to non-banking institutions. For the reason that in case of failure of such large non-banks and banks, government will have to use taxpayer funds to absorb such
In 2008, when the financial crisis occurred, millions of Americans were left without jobs and trillions of dollars of wealth was lost wealth. To make sure the Great Recession would not happen again, President Barrack Obama put into effect the Dodd- Frank Act. With the help of this law, banks will not be able to take irresponsible risks that had negative effects on the American people. Furthermore, with the Volcker Rule embedded into the act, it will ensure that banks are no longer allowed to own, invest, or sponsor hedge funds, private equity funds, or proprietary trading operations for their own profit, unrelated to serving their
History has shown us again, and again that when power is left unchecked it becomes corrupt and out of control, that is the iron law of oligarchy. In the US we saw this happen recently in the 2008 economic meltdown. The banks and corporations should never have been aloud to become "to big to fail," and once they did grow to a point when they were there should have been more government oversight to make sure things did not get out of hand. After the great depression laws were put in place to try to prevent something like that from ever happening again, but we undid those restrictions and ended up in a place eerily similar to somewhere we had been before. In this paper I will cover a brief history of the great depression, and show how the situation in 2008 was all too similar. I will also discuss and analyze the factors that brought us to the tipping point in our most recent economic scare. And finally I will explain why the actions taken by the FED were necessary and kept us from an even more
The old saying the fox is going to watch the henhouse is some of it for same problems we run into with regulators regulating themselves. Part of the systemic problem that existed in the late part of the first decade of the 21st century were government entities known as Fannie Mae and Freddie Mac. Both of these government institutions would just as responsible as the banks themselves for the crisis that took place and sworn new regulation which may not be far-reaching enough.
Today banks are regulated, unlike in time prior to this event which partly caused the “epidemic of bank failures”. People now commonly have at least some knowledge of how banks function, contrasting people of the banking crisis
The federal government’s role is in regulating industries is to protect consumers and the market. There is an ongoing debate on whether the federal government should regulate the insurance industry as a result of the bailouts stemming from the Financial Crisis of 2008. Currently, state governments regulate the insurance industry. Proponents of federal regulation reason that states are inefficient in the duty of insurance regulation. Additionally, the federal government has economies of scale and may offer an increase in efficiency unlike state regulation. The federal government regulates industries due to inherent systemic risk to the country’s economic environment. Systemic risk is the risk of collapse of an entire financial system or market. (SOURCE) For example, banking institutions such as Lehman Brothers, Merrell Lynch, and Goldman Sachs were major contributors to the financial crisis in 2008 because these institutions were systemically significant to the market. The insurance industry and the core activities of the industry, however, were not a major contributor to near-collapse of the American economy. The federal government should not regulate the insurance industry because it does not possess a systemic risk to the market economy, states have the ability and resources to regulate, and federal regulation would result in unnecessary costs from the federal budget.
“Too Big to fail” was first known in a 1984 Congressional hearing where Congressman Stewart McKinney discussed the Federal Deposit Insurance Corporation’s intervention with Continental IIIinois. The idea interprates that certain financial institutions are so large, if any of them fails, it will bring an unexpected disastrous effect to the economy. As we all known, the 2008 financial crisis had arose the “too big to fail” problem to the peak controversial point. Banks, insurance companies, auto companies are part of the big company industry. They make profit by creating and selling complicated derivatives and trading loans, commodities and stocks. When the big economic environment is prosperous, those big companies make a competitive
In this essay I will be addressing the “Too Big To Fail” (TBTF) problem in the current banking system. I will be discussing the risks associated with this policy, and the real problems behind it. I will then examine some solutions that have been proposed to solve the “too big to fail” problem. The policy ‘too big to fail’ refers to the idea that a bank has become so large that its failure could cause a disastrous effect to the rest of the economy, and so the government will provide assistance, in the form of perhaps a bailout/oversee a merger, to prevent this from happening. This is to protect the creditors and allow the bank to continue operating. If a bank does fail then this could cause a domino effect throughout
“There’s too much bad regulation and not enough good regulations at the moment. We should be giving people more, and better, guidance to help. The typical reaction is to add more regulation, but history shows this doesn’t necessarily change behaviour. Any further regulation needs to be really good – specific and direct. Regulators are putting more and more requirements into a system that isn’t working; need to fix this before adding more and they need to take a more innovative approach – a mixture and blending of roles between all external parties.”