Criminal punishments (jail time) might work. I think that taxing transactions in financial products would help a lot more, making the finance industry smaller, which I think would be very beneficial to society.
Making big banks smaller also will not help socially because banks have returns to scale in diversification. So bigger banks are less likely to fail by themselves, and can lend for lower rates, which is socially good (recent research [1] [2] indicates this might not be true for the biggest banks -- they exhausted benefits of scale).
Now one might ask if "too big to fail" effects might incentivize the bigger banks to act recklessly and counteract the above benefits? The answer is that there's the evidence does not back that up [3] at least for 2008 [4]. But that doesn't mean it is or is not the case going forward.
Why did banks act so recklessly if they were not acting on too big to fail incentives, then? The answer, like in the OP, is management incentives. The managers could not give less of a fuck if the bank failed, because they were incentivized by shareholders, in the form of bonuses, etc. to generate large year-over-year profits. And in any market close to efficient, the only way to do that is to take on large risks.
Not only did the managers not lose money if the bank failed, they didn't have any personal risk whatsoever. The lead up to 2008 was perfectly strategically rational coming from a bank manager's point of view.
As the poster above me says, one way to fix that is to impose penalty from the judicial system. There's only so much financial regulation can do. But DoJ has been awful at that, even clearly criminal acts (remember HSBC?) doesn't send management to jail.
[1] http://commons.colgate.edu/cgi/viewcontent.cgi?article=1053&...
[2] https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2655448
[3] http://fic.wharton.upenn.edu/fic/papers/11/11-47.pdf
[4] Remember the official fed policy was not to bailout banks coming into the crisis. They let the first behemoth fail, but quickly realized the disaster that awaited the global economy if they let the next one fail.
Since recorded history, natural interest rates have hovered around 6%. We are at an unnaturally low period of history. With it has been the weakest recovery since WWII. That's a demand issue.
That's your interpretation. Mine is that Henry Paulson happened.
A smaller financial sector would stabilise the financial and economical system, albeit at a lower level of economic activity. The less rich and powerful suffer most from economic instability. They also stand to gain most from increased stability. Ask people from the Baltic states about what happened in 2008-2009...
Who is the biggest beneficiary of credit? Us, the rich and powerful!
Have a look at the most expensive thing most people ever buy in their lives: a house! Housing prices and interest rates are directly linked. More expensive lending would mean lower housing prices. To some extent, deflating that bubble is actually a good thing for the less rich and powerful!
That benefits people who can pay in cash. Otherwise, the difference in price goes to the bank as interest.
Especially those who are underwater on their home loan.
The industry shrunk in the great depression and also in 2008.
Do you really want to bring that on again?
Also, the rich get richer in recessions relative to poorer people.
I may be uninformed, but this does not seem logical to me.
I'd say that
1) a smaller finance industry has lower costs, which should more than offset other effects and
2) cheap lending is part of the problem itself, because this cheap money is used (by the finance industry itself and wealthy people) to buy things that are already there (such as real estate, or businesses), inflating its price, after which they will extract more rent from it, as it is now increased in value. This is much easier and less risky than investing money in new economic activities. I understand that only a small percentage of lending actually goes into new economic activities, the vast majority is used to transfer ownership of pre-existing things, increasing the costs for society.
First, what are you going to tax? Credit card use? Home loans? Business loans? Exchanging money? Debit card use? Deposits & withdrawals?
Secondly, making the financial industry smaller makes the economy smaller. There is a direct relationship. So if you want to shrink it, realize that your job, my job, and everyone here on HN will have their job at risk from a shrinking economy. The financial industry shrunk in 2008, and also in the great depression.
You might want to understand the cause and effect in the business before you make comments like your last sentence.
There are some simple solutions to the financial misbehavior, but politicians on both sides aren't interested in doing them. Shrinking the industry and taxing transactions aren't solutions.
This theory breaks down if you distinguish between banker and bank as per the article.
In the short term, the crooked banker with insurance can out-compete the honest uninsured banker by making high risk loans, not caring if the loans are paid back. In the short term the crooked banker can accumulate tens or hundreds of millions of dollars and happily retire when in the long term the loans fail and the bank goes bankrupt.
The honest banker has to explain to his share holders etc. why crooked banker's bank is growing so much faster than his bank. His borrowers have to compete for houses against borrowers from crooked bank who can borrow more and therefor pay more for houses. His "under-performing" bank may become an acquisition target of crooked bank.
The requisites for this dynamic are the absence of fear of criminal prosecution and perverse incentives via excessive CEO compensation.
Insurance isn't some magic thing that you just go get, it has a price set by well informed underwriters.