By Stephen Grenville
Bill Poole’s suggestion for a market-based answer to too-big-to-fail is a useful contribution to the on-going debate, and this response is in the same spirit: we need debate to sort out how to fix a failed system.
The Poole proposal may be market-based, but it would introduce a substantial structural distortion by requiring banks to do something that is painfully expensive for them (this subordinated debt sits next to capital, and thus will be about as costly as capital). The market response would undermine its benefits. Even the old capital requirements (in effect much less than half the requirement of the Poole proposal) produced two market responses: evasion (as we have learned, capital ratios were actually much lower) and avoidance (the growth of the shadow banking sector, including institutions which turned out to be too-big-to-fail). Read more