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The strategist: US should have let more banks fail, says Fama
by Daniel Grote on May 06, 2009 at 00:01
The US government bail-out of the country’s stricken banks is likely to lead to a fragmentation of the sector, with investment bankers quitting the major retail banks in the face of increased regulation, according to Professor Eugene Fama.
Fama, author of the efficient markets hypothesis, who sits on the board of Dimensional Fund Advisors, said further regulation of banking as a result of the government taking increasing stakes in banks would purge the sector of its investment banking arms.
Speaking at the London campus of The University of Chicago Booth School of Business, Fama said: ‘The government setting income ceilings on bankers is going to cause investment bankers to exit the banks and set up their own firms, which in my view is very healthy. It was a mistake for the banking business to move from being partnerships to being corporations when they played with people’s money.
‘It turns out most of the banks are now investment banks as well and that was probably the big fly in the ointment in terms of the financial sector over the last 25 years.’
Too much government intervention
Fama was critical of the US government’s handling of the banking crisis, and argued that the government would have done better to let market forces take their course.
‘I would rather that they did not respond as much as they did,’ he said.
‘I would turn around the logic that says they [the banks] are too big to fail. I would say they are too big not to fail. Those are the ones that should be scrutinised most definitely and shut down when they fail. I would love to have seen Citibank shut down. That would have really sent the frighteners through the financial sector,’ he said.
He argued that allowing a bank to fail was a relatively straightforward process that preserved the human capital in the company.
‘If a bank fails, the human capital involved in that bank doesn’t get lost. The FDIC [Federal Deposit Insurance Corporation] knocks off the stock holders, knocks off some of the bond holders and sells off the assets,’ he said.
‘Once you knock them out, it turns out to be usually pretty easy to sell off the assets,’ he added. ‘Even in this crisis, Wachovia, Washington Mutual, IndyMac Bank – they’ve all gone through this process with no problem.’
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