Simon Johnson, a professor of economics at MIT, asks an interesting question in a NY Times column: why not break up Citigroup.
Professor Johnson has been arguing for breaking up the too big to fail since the beginning of the credit crisis. This week, Dallas Fed President Richard Fisher also called for downsizing the large financial institutions.
The question is how to go about it?
Regular readers know that your humble blogger supports the idea of requiring each bank to disclose its current asset, liability and off-balance sheet exposure detail. By requiring this disclosure, government ends the moral hazard surrounding these banks.
No longer do governments have a moral obligation to bailout investors after disclosing the results of bank stress tests and assuring them that the banks are solvent.
Instead, with this information, market participants can now independently assess the risk of each bank for themselves. With the ability to assess the risk comes the responsibility for accepting any gains or losses that result on an exposure to a bank.
As a result, management will face significant market discipline to reduce the bank's risk profile. How the bank chooses to reduce its risk profile is a choice that should be left to management.
The alternative is for regulators to require a 'Citigroup' to be broken up. There is no reason to believe that the results of this regulatory requirement will be better for the financial system than the results produced by management responding to market discipline.
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