Friday, October 10, 2008

A spitball solution to the problem

So if you are up on current events you are probably aware that we are in the middle of a financial situation melting down (interesting side note - there is a good explanation about the why this happened here and here). Now the question becomes how to deal with the problem and how to prevent it from happening again.

I have a solution that I think should be considered. One of the factors that contributed to the problem is the disconnect in the system. Bad loans were originated, purchased by another party, sliced-and-diced into another product and sold ad nauseum. When the blame question is raised to pin responsibility for the action it becomes very messy. Couple this with the scale factor. The institutions involved are huge banks. These titans were considered "too big to fail" (lesson one: nothing is too big to fail) but as they are coming apart just due to their sheer size they are pulling the system down. With these two points in mind here is my solution and why I feel it will unfortunately be overlooked.

The long-term solution lies in smaller financial institutions. Small banks (or better yet credit unions) who know who they loan the money to (like the neighbor down the street), and hold their loans for the whole duration. Smaller businesses are quicker to respond to what is going on. Also realize that the United States is economically diverse. Smaller banks would be able to adapt to the specifics of the area they serve. One things that is nice is that if we had smaller institutions the risk would be spread out. If this disaster were to have occurred it might wipe out a few banks but it wouldn't threaten the whole system. Smaller banks would fix the disconnect and the scale issues.

I think this would be a better solution then the current consolidation and global actions. Central Banks around the world are coordinating their efforts. Globalizing the banking system is the path that policy makers are tending towards. I think they are convinced if they get bigger they will eventually become too big to fail. I just don't think they are considering the small option.

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