Friday, July 20, 2012

Too big to fail and moral hazards

Since the financial crisis began in 2008, it has been usual for policy makers to deal with the issue “Too big to fail”. What is the meaning of this threatening sentence?. It refers to what to do with those financial institution which face either liquidity or solvency problems, and its influence is so wide and deep into the productive and financial sector, that it is not possible to let them fall , because it might transform a bank failure ,into a systemic failure with huge social and wealth cost. As a matter of fact , it has been said that after Lehmann Brother made public it will go broke(2008), global financial market went wild, and the subsequent economic event four years later, are somehow still being influenced by such a monumental collapse . Thus, it is not just a case for additional research the implications of this bankruptcy .It is a matter of fact which support the implications of big banks to fail. Going deeper in the correlation so to speak, between financial stability and economic growth , it is well established in the economic literature, the key role the financial sector has as the engine for economic growth. Literally when it fails ,there is not engine running ,therefore there is no growth . In the whole analysis and evaluations of the issue, it is assumed that Banks are managed by strict rules, precisely because it cannot afford to be even close of such risk .Besides , the cost of supporting banks in trouble pass through to society ,but not to the Bank itself because it is crucial to keep it on going. Somehow ,it is expected from Bank managers some level of social responsibility, equivalent to the one policy makers face, when they decide not to let a financial institution to fall. Some important assets like credibility , integrity , prestige, are expected to have a key role when it comes to managers decisions. However, recent events in the financial community ,( Interfering in the Libor level in the UK), indicates that such manager responsibility do not apply . Some reasons as follows : a.- The moral hazard, which deal with riskier conducts and management decisions, given the umbrella of protection which arise from the “too big to fail “ constraint for policy makers decisions. Moral hazard can goes further on, up to the point of breaking the law and betraying market confidence. b.- The so called dilemma between the “managers “ the “shareholders”, and these days ” the “stakeholders”. All of them might have different , even contradictory approach, to get the expected targeted profit. What are the implications ? a.-The first instinctive reaction, is to get tougher regulations. But regulations might work for some time, because sooner or later, it might become obsolete given the dynamic nature of financial issues and banking sector. Besides, regulations do not deal with the issue of principles . This does not mean that lack of regulation, or self regulation are better alternatives. It is just a matter of having the effective regulation- b.-Perhaps a better option would be, to adhere to some management codes of responsibility. Banks should be socially accountable, just like firms dealing with environment are. The ISO 26000 or a different standard one ,is waiting to have the Banks inside.