From the Washington Post via TPM:


This has been my big concern for some time about how our government was responding to the credit crisis.  Their solution was to prop up the existing banks, selling failing banks to the biggest players and making the "too big to fail" banks even bigger.  This will all be fine and good in the short run, but it is guaranteeing disaster down the road. 

These banks now know they they are fundamental to the functioning of our economic system.  Therefore they have every incentive to take very large risks.  Also, they will have a competitive advantage against any other bank because they are, in effect, backed by the federal government.  It will make it cheaper for them to borrow money and so they'll be able to get better returns.  If you can borrow at below market rates and get above market returns you're going to make a hell of a lot of money.

While the government may make regulations to reduce some of the immediate problems we had last year in terms of credit default swaps, etc, it won't much matter if we have these monstrous banks running around.  They will find ways to leverage themselves into very dangerous situations because the profit motive dictates it.  Then when it all falls apart, the US government will get left holding the bag.  We'll end up with a serious collapse of our banking system that will likely make the Fall of 2008 look like a cake walk. 

There's been a lot of talk about nationalizing some of the banks that are effectively insolvent right now.  Obama and Geitner are shying away from this, trying to find ways to underpin these banks while cleaning out a lot of the garbage on their balance sheets.  It's entirely possible that their approach might work, but I still think nationalizing them would be better.

The reason for this is that we've created a tremendous moral hazard in the banking system.  Bank of America, Citi, Chase, etc, all know that they've been officially deemed too big to fail.  In the short term they'll try to minimize reasons for the government to just come in and take them over, but what happens after the crisis is past?  They will be even bigger than they were before this happened and on top of that they'll know full well that they are untouchable.  That they can take any crazy risk they want because if things go badly, the government will come to the rescue and they'll still get their bonuses and options.

We need to nationalize these banks so that we can move in and break them up into smaller banks that we can more adequately regulate.  Having these megabanks is extremely dangerous for the economy because if any one of them fails it causes a chain reaction that takes the economy as a whole down.  So unless we move in and resolve that problem we're only pushing back the catstrophe, rather than preventing it.