If you have a chance, please have a look at my National Review column for an update on some recent progress in ending government distortions in the US financial sector. One angle on the issue that I fail to mention is how TBTF actually prevents market forces from restructuring Too Big To Manage megabanks. The Financial Times fills in that gap:
A closer look tells us why they cannot yet succeed in forcing big finance to spin off units to be better run, nimbler, more competitive and more effective in the manner of the big 1980s and 1990s industrial takeovers and conglomerate restructurings. Consider the incentives for restructuring too-big-to-fail financial firms. Suppose active shareholders were to decide that, say, a large bank would be better run if its biggest units were spun off into smaller ones. An active investor – in the mould of Carl Icahn or T. Boone Pickens – might eye up the companies and naively agitate for a break-up. “A company this big and complex can’t be managed well, no matter how good the chief executive is,” they might say. “It is worth twice as much broken up.”
But once they began working through the maths of a restructuring, they would find that shareholder values would not shift upwards in the way they might have predicted.
If the banking conglomerates were carved up into their constituent parts, the individual units would have a much higher cost of capital. Today, when financial conglomerates such as JPMorgan borrow to finance themselves, their creditors know the government will probably pay them back in full even if the bank fails because the systemic economic costs of their failing to do so is too large. Creditors therefore charge the conglomerate less. So the firm’s cost of capital becomes cheaper.