The problem with “too big to fail” can be summed up in 4 words: Private gains, public losses.
Take Detroit’s recent bankruptcy, for example. The NY Times reports that Detroit made derivatives bets in 2005 with UBS and Merrill Lynch (now Bank of America) wherein ”the banks would pay Detroit if interest rates rose, and Detroit would pay the banks if rates fell.”
This wasn’t a good decision for Detroit.
By 2009 interest rates were falling, and Detroit was getting hammered by these derivatives bets. In other words, Wall Street was raking in money from the deal—something they were happy to do.
Now that Detroit has gone bankrupt, these banks won’t suffer much (which is what is really galling). They’ll get to keep the money they’ve already made on the derivatives bets, while people with pensions will lose the money previously promised to them.
It’s not an equally shared sacrifice.
We see this over and over again: Wall Street receives private gains, and the public gets stuck with the losses. This is why the NY Times article ends with these poignant words:
Detroit’s problems are a reminder of broader challenges, identified but still unmet: protecting pensions; protecting municipalities from Wall Street; and, at long last, revoking the obscene privileges of banks that allow them to prosper on the failings of others.
Wall Street Banking in 4 words: Private gains, public losses.
— Eric Scott Hunsader (@nanexllc) August 3, 2013