There is a lot of talk about how we need more governmental regulation of today's enormously complex financial markets, but the obvious problem with that is that barely anybody understands how today's enormously complex financial markets work, and those that do generally have better things to do than get paid at civil servants' salary levels.
So, what we need are a few new but simple regulations. But those are hard to come up with. Let me toss one idea out there: We shouldn't permit financial institutions to get too big to fail.
The analogy to antitrust legislation is obvious: we don't permit businesses to get too big to compete, so why let financial firms get too big to fail?
For example, in 1987 the Reagan Administration Department of Justice vetoed the acquisition of the marketing research firm I worked for by Nielsen because it would leave only two competitors in the consumer packaged goods sales data industry. You didn't even know there was an industry that measures whether Crest or Colgate has higher market share? Well, it's not much of an industry, but the Reagan Administration considered it important enough to insist that it be a three company industry rather than a two company industry. This decision may have cost me, say, $100,000 or more in paper profits on my stock options in my employer, which went from worth $20 per share to below water, but I don't recall too many being outraged by my loss. That's how the antitrust laws work, going back to 1911, when the Supreme Court ruled that the Standard Oil Company should be broken up under the 1890 Sherman Anti-Trust Act. Standard was split up into three separate competitors.
Why not do the same thing to firms threatening to be too big to fail?
First, once this crisis is over, don't approve mergers that would create firms above a certain threshold in too-big-too-failness.
Second, firms that are already over the threshold would be given, say, three years to split themselves up into firms under the limit. Fast growing firms could plot out their futures and make plans to voluntarily divest themselves of some units, or split like amoebas before they reached the penalty threshold.
This doesn't penalize stockholders unduly (other than that they lose their too-big-too-fail premium). Instead of holding one share of TooBigtoFail Inc, they hold one share each in PrettyBig Inc. and FairlyLarge Inc. Are there enormous economies of scale in the financial industry that would be lost? Perhaps, but how do they compare to all the other losses we've seen due to too-big-to-fail moral hazard? If you want FDIC insurance on your million dollars in bank savings, the government doesn't let you keep it all in one bank, even though there would be economies of scale in doing that. It forces you to diversify among ten banks.
We already know how to do this in antitrust law. We've been doing it for 97 years, and it's not all that controversial anymore.
Why let them get that big in the first place?