Hi Andrew,

I am in complete agreement with you that “the moment it is accepted that certain financial firms are too big to fail (and they are) is the moment that we have to ask whether those firms are too big to exist.”

I do not believe, though, that there is even a slim chance that the answer to this problem lies in making this government guarantee explicit and trying to properly price it.

As you correctly observe, “properly” is difficult. AIG and others tried to price the risk of guaranteeing investors against losses on complex financial securities, and failed.

The federal government purposely misprices many of the things it guarantees, including flood insurance for people who live in hurricane regions. The political considerations outweigh the economic considerations.

That would be the case — many times multiplied — in financial services. In some ways, it’s the story of the past 25 years.

Moreover, I don’t think it’s necessary for the government to make this “too big to fail” guarantee permanently explicit and to pretend to try to price it.

“Too big to fail” is a new phenomenon. It started in the eighties. It takes only minimal political competence and credibility for Washington to end it.

Washington must only apply existing regulatory principles to new markets, making the financial industry more robust to periodic failures of firms and investment classes. These regulations include clear, uniform limits on borrowing and exposure as well as requirements for disclosure of risk.

We have done this before, and we can do it again.

For more about this — a lot more! — you’ll have to read my book.

– Nicole Gelinas is contributing editor to the Manhattan Institute’s City Journal.