Three years ago, as the world’s largest banks teetered on the edge of collapse, the global financial system nearly experienced the financial equivalent of Armageddon. When Lehman Brothers finally went under in September 2008, the chaos that ensued was largely blamed on a wide-scale embrace of the "too big to fail" mentality. Put simply: America’s largest financial institutions were considered too large, too complex and too hopelessly interconnected to ever be allowed to collapse. That is no longer the case, now that the FDIC, Federal Reserve and Financial Stability Oversight Council have united on the mandatory creation of "living wills" for the largest banks in the country.
The idea behind these "living wills" is simple — before a large financial institution is ever allowed to reach the precipice, it will be required to lay out, point-by-point, exactly how its assets would be distributed in the event of its demise. Contrary to the wonderfully elegant risk calculation models of the Wall Street moneymen, there are, indeed, Black Swans in the financial universe — and far more than might be expected. Making sure that banks like Citigroup, J.P. Morgan Chase and Bank of America have contingency plans in effect is a way of ensuring that a $700 billion bailout of the banking system will never be required again.
By next July, the nation’s largest banks with more than $250 billion in assets — the likes of Citigroup, J.P. Morgan Chase, and Bank of America — will be required to detail how they should be broken up if they, indeed, need to be broken up in the future. By Dec. 2013, any bank or bank holding company with more than $50 billion in assets will be required to present an orderly plan for how their assets can be liquidated before they file for bankruptcy. Even foreign banks with significant exposure to the U.S. market will be required to put together a comprehensive contingency plan.
Mitt Romney may have drawn fire for his campaign remark that "Corporations are people,” but perhaps we’re finally starting to recognize that corporations are indeed living, breathing organisms connected to larger ecosystems. What the largest corporations do on a daily basis has enormous repercussions for the average American. Taking out even a single member of this group can cause a carefully regulated system to unravel. In other words, even "Government Sachs" is no longer too big to fail. This means we should never actively hope that any of the largest Wall Street banks ever goes under.
There is, in fact, an entire branch of economics known as evolutionary economics that makes the case for thinking of companies and other economic actors as part of a connected ecosystem. Instead of thinking of corporations as soulless, purely rational, profit-seeking machines, it is far more instructive to think of them as irrational entities caught up in a Darwinian free-for-all. This challenges regulators to think of banks not as purely rational economic actors, but as part-and-parcel of a very fragile ecosystem.
Living wills in the real world, of course, are not without their critics. These documents, in which people who lay out how to keep themselves alive in the case of medical incapacitation, can be controversial since they necessarily require thinking about our mortality and the ethical issues raised by euthanasia. When individuals are at risk of losing their grasp of the mortal world, are there any circumstances when that life should not be prolonged? The same is now true in the financial world, where no one is too big to fail if the circumstances have become sufficiently dire.
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