The diploma thesis examines the TBTF-Problem with the main focus on systemic risk, moral hazard and distortion of competition. These phenomena are explained as the immediate consequences of the financial institutions oversize. In order to solve the TBTF-Problem I have used teachings of Leopold Kohr’s size theory, which helped to construct a proposal for the reform of financial system structure and to give new perspective on its regulation. According to the theory there is a certain limit from which manageable becomes unmanageable, controllable becomes uncontrollable, and from which further development does not lead to progress, but to collapse. Thus, the problem of modern economic and, in particular, financial system is not the way how to stimulate growth, which became itself own purpose, but how to avert it. When someone at once arrives on the brink of abyss, the reasonable is only to step back. Therefore, the only cure for current financial instability is the division of TBTF institutions that have outgrown manageable proportions. For this purpose I recommend a three-tier financial system by which these ideas are operationalised.
In addition the thesis discuses the regulatory framework, concentration and consolidation of the financial marker in US, that made the genesis of TBTF-Institutions possible. Furthermore I explain US housing bubble and the way of its emergence, including “originate and distribute” model, structured financial products as well as Ponzi scheme as an example of confidence game.
Contents
1 INTRODUCTION
2 FINANICAL SERVICE SYSTEM COMPONENTS AND THEIR IMPORTANCE
3 HISTORIC DEVELOPMENT OF FINANCIAL SAFETY NETS AND REGULATORY FRAMEWORK
4 INTERNATIONALIZATION, MODERNIZATION AND CONSOLIDATION OF THE FINANCIAL INDUSTRY– THE WAY TO THE LATEST FINANCIAL CRISIS
4.1 FINANCIAL INTERNATIONALIZATION AND POLICIES
4.2 FINANCIAL INNOVATION
4.2.1 Originate and distribute model – Credit Securitization (Mortgage-backed securities, Collateralized debt obligations and Credit default swaps)
4.2.2 Rating agencies
4.2.3 Short-term financing
4.3 CONSOLIDATION OF FINANCIAL INDUSTRY AND MEGAMERGERS – THE GENESIS OF TBTF INSTITUTIONS
5 BOOM AND BUST – THE HOUSING BUBBLE
5.1 THE BOOM
5.2 PONZI SCHEME
5.3 THE BUST
5.3.1 Bear Sterns
5.3.2 Lehman Brothers
5.3.3 AIG
6 FINANCIAL CRISIS (2008- ) – THE BAILOUT OF THE FINANCIAL SYSTEM
6.1 RECAPITALIZATIONS
6.2 DEBT GUARANTEES
6.3 ASSET PURCHASES OR GUARANTEES
7 WHY TO INTERVENE? – SYSTEMIC RISK
7.1 TRIGGERING EVENT
7.2 PROPAGATION MECHANISM
7.2.1 Counterparty contagion
7.2.2 Information contagion
7.3 EFFECT ON THE MACROECONOMY
8 THE HAZARDS OF MORAL HAZARD
8.1 MORAL HAZARD AND GOVERNMENT OFFICIALS
8.2 MORAL HAZARD AND RISK-TAKING
8.2.1 Moral Hazard and Creditors
8.2.2 Moral Hazard and Shareholders
8.2.3 Moral Hazard and financial firms executives
8.2.4 Moral Hazard and private investors
9 DISTORTION OF COMPETITION
10 TOO BIG
11 THE SIZE THEORY TEACHINGS
11.1 DEALING WITH MORAL HAZARD
11.2 THE PHYSICS OF THE FINANCIAL SYSTEM
12 CONCLUSION
Research Objectives and Topics
This thesis examines the concept of "too-big-to-fail" (TBTF) financial institutions, analyzing the historical development of financial safety nets and the systemic risks that arise from the consolidation of the financial industry. It explores the complex relationship between government intervention, moral hazard, and financial stability, specifically questioning why large, interconnected institutions are bailed out, the consequences of such policies, and potential alternatives for future financial system regulation.
- Evolution of financial safety nets and regulatory frameworks.
- The "too-big-to-fail" doctrine and its role in systemic risk propagation.
- The impact of consolidation and megamergers on financial industry stability.
- Moral hazard behavior in government officials, financial executives, and creditors.
- The physics of financial systems and the argument for smaller, more sustainable financial units.
Excerpt from the Book
4.2.1 Originate and distribute model – Credit Securitization (Mortgage-backed securities, Collateralized debt obligations and Credit default swaps)
An originate-to-distribute (OTD) model of lending, which was a popular method of mortgage lending before the onset of the subprime mortgage crisis, means that the originator of a loan sells it to various third parties. Because the bank and other financial institutions intend to sell the mortgage loan, they tend to originated excessively poor quality mortgages (Purnanandam 2010). As banks do not intend to keep a mortgage loan on their balance sheet until it is repaid, banks that sell loans would also have a reduced incentive to engage in costly screening and monitoring of the borrowers (Berndt and Gupta 2009).
The “originate and distribute” model was possible with the development and advances in the credit securitization process. The practice of securitization has simply set the stage for financial crisis (Eichengreen 2008a). Over the past twenty years, financial institutions have upgraded strategies of securitizing credit. However, whereas the securitization spread risks, it also has tendency to raise it.
The securitization of loans is a complex process that involves several different players. It enabled large and complex financial institutions to earn large amounts of fee income (Wilmarth 2010). Mortgage brokers, commercial banks, investment banks and other financial institutions offered exclusively one part of the services in loan transition and transformation process on its way to be sold and resold to the global financial world.
Summary of Chapters
1 INTRODUCTION: This chapter introduces the global financial crisis and defines the "too-big-to-fail" (TBTF) problem in the context of interconnected and complex financial institutions.
2 FINANICAL SERVICE SYSTEM COMPONENTS AND THEIR IMPORTANCE: This chapter provides an overview of various financial institutions and their essential roles in the financial intermediation process, while emphasizing the regulatory importance of depository institutions.
3 HISTORIC DEVELOPMENT OF FINANCIAL SAFETY NETS AND REGULATORY FRAMEWORK: This chapter tracks the development of government safety nets, including deposit insurance and the lender of last resort facility, following the Great Depression and the subsequent regulatory shifts.
4 INTERNATIONALIZATION, MODERNIZATION AND CONSOLIDATION OF THE FINANCIAL INDUSTRY– THE WAY TO THE LATEST FINANCIAL CRISIS: This chapter discusses how deregulation and consolidation paved the way for the recent financial crisis through financial innovation and the growth of megamergers.
5 BOOM AND BUST – THE HOUSING BUBBLE: This chapter analyzes the housing bubble's formation and collapse, explaining it through a Ponzi-scheme perspective and highlighting the failures of key institutions like Bear Stearns and Lehman Brothers.
6 FINANCIAL CRISIS (2008- ) – THE BAILOUT OF THE FINANCIAL SYSTEM: This chapter summarizes the multi-trillion dollar government interventions, including recapitalizations and asset purchases, used to rescue the financial system after the crisis erupted.
7 WHY TO INTERVENE? – SYSTEMIC RISK: This chapter investigates the incentives for government intervention and the multifaceted definition of systemic risk in the financial and real economy.
8 THE HAZARDS OF MORAL HAZARD: This chapter explores the moral hazard created by TBTF policies among government officials, bank executives, creditors, and investors, and how it induces excessive risk-taking.
9 DISTORTION OF COMPETITION: This chapter examines how TBTF policies provide unfair competitive advantages to large institutions and the subsequent impact on market discipline.
10 TOO BIG: This chapter reviews the list of systemically important institutions and discusses the lack of regulatory accountability for these firms under the existing "prompt-corrective-action" regime.
11 THE SIZE THEORY TEACHINGS: This chapter argues that the solution to financial instability lies in the "size theory," proposing a division of oversized institutions to prevent the accumulation of uncheckable critical power.
12 CONCLUSION: This chapter concludes that the restoration of stability requires cutting down oversized financial institutions to manageable proportions and organizing the market structure into tiers.
Keywords
Too-big-to-fail, TBTF, Financial crisis, Moral hazard, Systemic risk, Securitization, Financial regulation, Consolidation, Bailout, Credit default swaps, Housing bubble, Market discipline, Financial stability, Banking reform, Leverage
Frequently Asked Questions
What is the central focus of this thesis?
The thesis focuses on the "too-big-to-fail" (TBTF) problem in the financial sector, examining how government safety nets and regulatory policies have contributed to systemic risk, moral hazard, and excessive risk-taking among large financial institutions.
What are the primary themes discussed?
Key themes include the historical evolution of financial regulation, the mechanics of securitization, the development of the housing bubble as a Ponzi-like scheme, the influence of executive compensation on risk-taking, and the economic justification for government bailouts.
What is the core research question?
The core research investigates why regulators continue to support systemically important institutions, the negative consequences of these bailouts, and how to restructure the financial system to avoid future instability.
Which scientific methods are employed?
The author employs a conceptual disputation approach, analyzing literature on financial history, economic theory regarding moral hazard, and contemporary institutional frameworks to argue for a structural reform of the financial industry.
What does the main body cover?
The main body covers the development of financial safety nets, the rise of financial innovation and securitization, the progression of the 2008 financial crisis, and theoretical arguments regarding power accumulation and the optimal size of organizations in the economy.
Which keywords characterize the work?
The work is characterized by terms such as TBTF, systemic risk, moral hazard, securitization, financial consolidation, bailouts, and market discipline.
How does the author characterize the role of credit default swaps (CDS)?
The author characterizes CDS as "weapons of mass destruction" that increased market interconnectedness, creating a scenario where dominant firms became "too interconnected to fail," thereby forcing government intervention.
What is the "size theory" proposed by the author?
The size theory posits that institutions should be kept at a size relative to their function. The author argues that beyond a critical size, management becomes unmanageable and institutions pose a systemic threat, necessitating their division into smaller, more sustainable units.
- Arbeit zitieren
- Vidak Saric (Autor:in), 2011, Too Big To Fail - Concepetual Disputation with Leopold Kohr, München, GRIN Verlag, https://www.hausarbeiten.de/document/170618
