Too Big to Sink

November 6, 2009 at 2:00 am 2 comments

Sinking Ship

If I got paid a nickel for every time I heard the phrase “too big to fail” to describe the state of affairs of our major financial institutions, I’d be retired on my private island by now. Jeremy Grantham, famed value investor and Chairman of Grantham Mayo Van Otterloo, recently compared the redesigning of our financial system to the Titanic and aptly described the hubris surrounding the ship’s voyage as “too big to sink!”

Mr. Grantham argues that many of the financial institution reform proposals have an irrelevant, misguided focus on improving the safety of the Titanic’s lifeboats rather than the structural design or competence of the captain. Maybe it’s better to plan for disaster prevention rather than disaster preparation?  Grantham adds:

“By working to mitigate the pain of the next catastrophe, we allow ourselves to downplay the real causes of the disaster and thereby invite another one.”

When analyzing system failures, incentives are important to understand too. For example, the ship was “under-designed” and the captain had an ill-advised reward baked into a compensation bonus, if he beat the speed record (see article on compensation).

The Solution

Rather than protecting the bankers’ interests, Grantham contends we need “smaller, simpler banks that are not too big to fail.” At the heart of these massive financial conglomerates, pruning is necessary to separate the risky, proprietary trading departments, thereby ridding an “egregious conflict of interest with their clients.” As a former fund manager for a $20 billion fund, I was acutely aware of how my fund trading information and my conversations were being tracked by investment bankers and traders for themselves and their clients’ benefit. When the banks are managing your money alongside their own money, greed has a way of creeping in.

Beyond the prop trading desk legislation, Grantham believes those financial institutions “too big to fail” should be cut down into smaller pieces that can actually fail. Many of these entities are already what I like to call, “too complex to succeed,” evidenced by the stupefied responses provided by Congressmen and the CEOs of the banking institutions during the aftermath of the crisis. Reintroduction of some form of Glass-Steagall legislation (separation of investment banks from commercial banks) is another recommendation made by Grantham.

These suggestions sound pretty reasonable to me, but the bankers scream “If we become smaller and simpler and more regulated, the world will end and all serious banking will go to London, Switzerland, Bali Hai, or wherever,” Grantham adds in a mocking voice. If the foreigners want to operate irresponsibly, then Grantham says let them suffer the negative consequences every 15 years, or so.

The political will of legislators will be tested if substantive financial reforms actually come to pass. Jeremy Grantham understands the extreme importance of reform as explained concisely here, “A simpler, more manageable financial system is much more than a luxury. Without it we shall surely fail again.” Fail that is…like a sinking Titanic.

Read Jeremy Grantham’s Full Quarterly Newsletter

Wade W. Slome, CFA, CFP®

Plan. Invest. Prosper.

DISCLOSURE: No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.

Entry filed under: Banking, Government, Politics, Profiles. Tags: , , , , , , .

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2 Comments Add your own

  • 1. Soros on the Super Bubble « Investing Caffeine  |  December 22, 2009 at 2:04 am

    […] Too Big to Fail (read related Graham IC article):  According to Soros a big reason we got into this trouble relates to the irresponsible […]

  • 2. Banking Surgery or Amputation? « Investing Caffeine  |  January 22, 2010 at 1:30 am

    […] fact, investment guru Jeremy Grantham makes the same argument in my Investing Caffeine article (“Too Big to Sink”). However, I think a more relevant question is, “How do we implement more responsible risk […]


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