More on "too big to fail"

Last week, I posited that any company "too big to fail" was too big to exist, and ought to either be broken up under anti-trust regulations, or should be nationalized if it needed to have such power over the marketplace.

Roman Werpachowski replied in the comments, saying that my underlying logic was "far-fetched," and that the solution was not nationalizing or breaking up these firms, but the creation of a more rational marketplace in credit default swaps and other exotic instruments, so that counterparty risk would be clearer.

I'm not an economist, and I freely admit that my sense that a company too big to fail shouldn't exist is largely a gut feeling. I happen to think that my anti-trust argument makes sense, especially since a lot of these companies got that big by mergers which were opposed by a prescient few on these very grounds.

Nonetheless, it's encouraging to note two things. First, that Henry Paulson, who does know something about finance, and about the current problems in the market, seems to agree with me, saying that:

We need to get to the place in this country where no institution is too big or too interconnected to fail.

This echoes what Matt Yglesias recommended at roughly the same time I was writing about banks being "too big to exist." Kevin Drum makes a reasonable counterargument to Matt's specific recommendations, but I suspect that one could implement these regulations in a way that leaves enough banks that are large enough to finance multi-national deals while maintaining enough competition in the market that no bank would be indispensable to the market.

I further note that smaller banks are almost all weathering this crisis much more successfully than the big banks. This won't last forever, since the market is so interconnected that the problems will eventually hit small banks, too. But a bank industry with more small banks would have provided more insulation against this sort of shock.

It's encouraging that my general policy gestalt matches the direction not only of the actual experts, but of the empirical evidence.