Big banks that took on high risks and generated unsustainable losses received a public benefit: TBTF support. As a result, more conservative banks were denied the market share that would have been theirs if mismanaged big banks had been allowed to go out of business. In essence, conservative banks faced publicly backed competition.
Let me make my sentiments clear: It is my view that, by propping up deeply troubled big banks, authorities have eroded market discipline in the financial system.
The system has become slanted not only toward bigness but also high risk. Consider regulators’ efforts to impose capital requirements on big banks. Clearly, if the central bank and regulators view any losses to big bank creditors as systemically disruptive, big bank debt will effectively reign on high in the capital structure. Big banks would love leverage even more, making regulatory attempts to mandate lower leverage in boom times all the more difficult. In this manner, high risk taking by big banks has been rewarded, and conservatism at smaller institutions has been penalized. Indeed, large banks have been so bold as to claim that the complex constructs used to avoid capital requirements are just an example of the free market’s invisible hand at work. Left unmentioned is the fact that the banking market is not at all free when big banks are not free to fail.
It is not difficult to see where this dynamic leads—to more pronounced financial cycles and repeated crises.
Ha! But common sense like this from a lone Fedster will never prevail against Wall Street lobbyists' cash with the likes of Dodd (D - Countrywide) and Frank (D - Fannie Mae) in charge.