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England's Central Banker on 'Too Big to Fail'
October 23, 2009
 
 
As the U.S. political class blames banker pay for the panic (see above), we'd like to salute Bank of England Governor Mervyn King for speaking a larger truth. Mr. King gave a speech in Edinburgh Tuesday in which he said, in effect, that if a bank is too big to fail, it's just too big. This prompted British Prime Minister Gordon Brown to shoot back that breaking up the largest financial institutions wasn't the answer, adding the now obligatory call for global regulation of banker pay.
 
One can disagree with Governor King's contention Tuesday that the banking system, and the economy, would be better served by a stricter division between investment banking and commercial or retail banking. But more important than Mr. King's solution was his diagnosis of the problem, which shows more understanding of what caused last year's panic than the usual pabulum about bonuses.
 
"Why," Mr. King asked, "were banks willing to take risks that proved so damaging both to themselves and the rest of the economy?" His answer: "One of the key reasons . . . is that the incentives to manage risk and to increase leverage were distorted by the implicit support or guarantee provided by government to creditors of banks that were seen as 'too important to fail.'" Politicians—and U.S. Federal Reserve Chairmen—hate hearing that it was their subsidies for credit and for the biggest banks that contributed to the problem.
 
Mr. King wasn't done: "Such banks could raise funding more cheaply and expand faster than other institutions. They had less incentive than others to guard against tail risk. Banks and their creditors knew that if they were sufficiently important to the economy or the rest of the financial system, and things went wrong, the government would always stand behind them." He concluded: "And they were right."
 
On this essential point, Mr. King is on target, and it's heartening to hear an important public official highlight the real problem so succinctly. Mr. Brown and U.S. politicians would prefer to point to inadequate "global regulation" of finance. But show us the regulator who could have prevented the panic, even with unlimited power, and we'll show you a world without the freedom to succeed or fail.
 
Printed in The Wall Street Journal, page A20