Wednesday, March 09, 2011

200 Years Later and Still No Wiser

More than two centuries ago, Adam Smith warned of the dangers of having financial institutions that were "Too Big To Fail." The paragraph below was taken out of a recent Barron's article:

Adam Smith discussed at length the 1772 collapse of the Ayr Bank in Scotland, which ended up costing the Duke of Buccleuch and other investors. It was laid low by "chimerical projectors…who would employ money in extravagant undertakings, which, withal the assistance given them, they would probably never be able to complete." It was important, Smith claimed, to limit the size of enterprises so that one bank failure wouldn't incinerate the entire financial system.

Does the above look familiar to you? Unfortunately, even after our most recent experience with the 2008 financial collapse, lessons still have not been learned. Wells Fargo, JP Morgan, Bank of America and Citi Bank are four major banks that got bigger, not smaller.

Even worse, now more than ever the housing markets are relying on Fannie Mae and Freddie Mac to help finance mortgages--two companies standing at death's door with outstretched hands asking for donations from the taxpayer.

We have come out of the 2008 crisis with even more financial institutions that are Too Big to Fail. What will the next round of profits and greed bring when the cycle turns down? More pain, not less, we suspect.

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