Forget About 'Too Big to Fail'

Size doesn't matter; the real problem is unregulated 'shadow banking'
By John Johnson,  Newser Staff
Posted Apr 2, 2010 8:15 AM CDT
A file photo of Lehman headquarters in New York City.   (AP Photo/Mary Altaffer, file)

(Newser) – Paul Krugman doesn't buy the "too big to fail" argument for a simple reason: "It’s perfectly possible to have a financial crisis that mainly takes the form of a run on smaller institutions." Big banks aren't the problem, he writes in the New York Times. We need to worry instead about so-called shadow banks and "update and extend old-fashioned bank regulation" to rein them in. He explains:

"What ended the era of US stability was the rise of 'shadow banking': institutions that carried out banking functions but operated without a safety net and with minimal regulation. In particular, many businesses began parking their cash, not in bank deposits, but in “repo”—overnight loans to the likes of Lehman Brothers. Unfortunately, repo wasn’t protected and regulated like old-fashioned banking, so it was vulnerable to a pre-1930s-type crisis of confidence. And that, in a nutshell, is what went wrong in 2007-2008."

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