How to cut megabanks down to size

http://www.nytimes.com/2013/01/20/business/a-fed-voice-asking-to-cut-megabanks-down-to-size.html

by sshumaker • 14 years ago

150 97 14 years ago

dmm• 14 years ago

Next time they blow up just let them all burn to the ground.

The people in charge are too afraid we'll go all "Lord of the Flies" on them without the banking system to motivate us into productivity.

mdda• 14 years ago

Suppose JPM/Chase had failed. The day after, there would be no cash in the ATMs (unless the government stepped in). The USA would be in a Lord of the Flies situation very rapidly. And we wouldn't be interested in the bank bosses, we'd be interested in food.

ef4• 14 years ago

An analogy:

Bank runs are like forest fires. If you prevent all the small ones, eventually you get a giant one that's too big to stop.

ataggart3• 14 years ago

>small institutions must submit to the rigors of the free market.

>market discipline has worked to keep smaller institutions on the straight and narrow, it has been ineffective with megabanks

>market participants have proved [in]effective in monitoring risks at these [huge banks].

>They know they will be protected by a taxpayer rescue should a large institution teeter.

How is this not obvious to everyone involved?

josephlord2• 14 years ago

Smaller banks survived this crisis with relatively few failures but that has not always been the case (e.g. Savings and Loans crisis). However the fact that they can fail is critical and a sufficient reason to break them up even if it won't make them better.

Banks that are too big to fail are too big to be allowed to exist. Government protection only for the commercial/retail part is an obvious but insufficient requirement.

ataggart3• 14 years ago

It's not clear to me how "bigness" matters. The article makes clear that small banks were exposed to disciplining market forces, but for large banks such forces were obviated by government protection. Worrying about size seems to miss the point.

eru• 14 years ago

Why have government protection at all?

cynicalkane• 14 years ago

They are obvious and breaking up the banks is a popular topic of speculation in the finance industry. What's a mystery is why it is taking so long for mainstream econ and op-ed writers to catch on.

Paul Krugman, for example, proposed that big banks like Citibank provide value by having a huge service network, and therefore he's skeptical of breaking up banks. Which is true--Citibank's size is the primary (and probably only) reason I'm a Citibank customer. But the unstated assumption that there must necessarily a 1:1 ratio of Too-Big-To-Fail bunches of assets to bank service networks is baffling to me.

There seems to be a TBTF blind spot in the sphere of wide-area economic and financial knowledge; that is just one example. The solution is always "more regulation", or occasionally, "better regulation" with the implication that everything is the government's fault.

anigbrowl• 14 years ago

What's a mystery is why it is taking so long for mainstream econ and op-ed writers to catch on.

I think they're quite familiar with the idea and have caught onto it long ago; they just don't want to be misrepresented as advocating a government takeover of the finance industry or as communists or whatever. It's not so much that they favor large institutions, as they're trying be moderate and consider both sides of the argument.

By contrast, read the editorial pages or the comment sections of the Wall Street Journal, in which Obama is regularly characterized as a Marxist ideologue and worse, and any sort of regulation or disciplinary action against the financial services sector is characterized a shakedown, at best. If the government actually proposed carving up the banks there would be (even more) howls for his impeachment. Much as only Nixon could go to China, a reset of the financial sector could only come from some prominent Republican, and a fiscally hawkish one at that.

azernik• 14 years ago

An example of how large collections of assets and large service networks don't have to have a 1:1 correspondence:

I'm a member of a two-branch credit union, but I get to use a fairly extensive service network through the Credit Union Service Center system, where a large number of small institutions share the customer-service side of their operations. In the SF bay area, I get full service from any of the several dozen branches of Patelco and USE, plus several smaller CUs.

qznc• 14 years ago

The only one who should be allowed to be too big to fail is the government itself. The logical conclusion is that everything which should be really big should be owned by the government. Then win and loss is for the society as a whole.

MichaelApproved• 14 years ago

"They know they will be protected by a taxpayer rescue should a large institution teeter."

This should be mitigated by the fact that shareholders will lose value, even in the event of a taxpayer rescue. Meaning, a bailout isn't a good insurance policy for a shareholder because they lose anyway. But that fear of a bailout doesn't seem to limit the risk appetite as I'd expect.

I think it's because regulation and control hasn't made this type of risk transparent to the shareholder. The shareholder isn't calling for these types of regulations because of fear the regulation would be overbearing and hurt profitability.

Often, over regulation is a shortsighted concern that allows a company to take on more risk than an investor would typically allow for (at existing valuations).

refurb• 14 years ago

Didn't the shareholders lose out during the past crisis? Just look at the beating the stocks of the major banks took.

richardw• 14 years ago

Shareholders have very little power over the big banks. The bank managers and traders have perfected demonstrating the principal-agent problem (link below). For example, huge bonuses being paid out even as the banks were being torn apart around them. Managers and traders kept arguing that they need to retain "talent", to the detriment of the supposed owners of the business.

http://en.wikipedia.org/wiki/Principal%E2%80%93agent_problem

More simply:

Taxpayers are suckers

Lenders are suckers

Shareholders are suckers

Managers and traders, not suckers.

rayiner3• 14 years ago

Because it's a narrative with no basis in fact? The smaller banks were the ones hardest hit by the popping of the financial bubble. GS/MS/JPM didn't need the bailout, Lehman and Bear Stearns failed in a free market manner, and Merrill Lynch was bought out. It was the smaller banks that really needed the bailout money.

glesica• 14 years ago

Merrill Lynch hardly failed in a free market manner. It was bought out based on guarantees from the taxpayers IIRC. GS also got help from the SEC in the form of a temporary ban on shorting. I'm not saying you're wrong, just that you've over-simplified the situation... there really aren't any free markets when it comes to finance.

SilasX• 14 years ago

Really? So it was the credit unions that were decimated by the crisis? Or did you just mean the "smaller of the giants"?

RockyMcNuts4• 14 years ago

1) that's factually incorrect, 2 of the top five Wall Street firms failed (Lehman and Bear Stearns).

2) the other 3 (Goldman, Morgan Stanley, Merrill Lynch) would have failed after Lehman, the entire financial system had to be backstopped by the government. (If you look beyond pure securities firms, the largest insurance company (AIG) failed as well as the largest bank (Citibank - it effectively got nationalized and shareholders were wiped out, look at a stock price chart (http://finance.yahoo.com/q/bc?s=C&t=my&l=off&z=l...)

The lesson learned is that the financial system can't survive a failure like Lehman without a government backstop.

So, pick your poison, either 1) permanent government backstop and some regulation to go with, it, ie don't let bankers run leveraged hedge funds on the public dime, take all the profits in good times and stick taxpayers with the bill when it goes south.

Or 2) smaller banks that can fail without taking the whole system down.

mattmcknight• 14 years ago

Systemic risk to an investment class such as mortgages, means that most banks would be subject to the same ill effects, and smaller less diversified banks will fail. There were 157 bank failures in 2010...zero in 2006. http://www.fdic.gov/bank/historical/bank/2010/index.html

However, just limit the amount of Federal Deposit Insurance that can be issued to one entity, if we can't figure out what they're doing.

ttar5• 14 years ago

Start the Bank of the United States, cancel FDIC insurance.

There problem solve.

ttar5• 14 years ago

FDIC is a form of privatizing the profit, while socializing the risks for the banks.

raverbashing2• 14 years ago

Yes

BUT it's also a form of "insurance". If there's a suspect a bank won't be able to honor deposits, bank run ensues, THEN the given bank can't honor deposits obviously, because no bank works like that today, that is: self fulfilling prophecy

It's a necessary evil (for the customer's sake)

natrius3• 14 years ago

The FDIC is funded by banks. The FDIC did not have to use taxpayer dollars during the financial crisis. In practice, the FDIC has not been involved in these socialized risks you speak of, though if it ran out of money, the government would back it up.

The FDIC also provides public benefits, like avoiding economy-crippling bank runs.

It's a good thing.

sc68cal• 14 years ago

We tried that. Our country has had great difficulty with central banking in the past, and today. Entire books have been written on this topic, if you wish to learn more, I'd start with the history of the First and Second bank of the United States.

https://en.wikipedia.org/wiki/First_Bank_of_the_United_State... https://en.wikipedia.org/wiki/Second_Bank_of_the_United_Stat...

ttar5• 14 years ago

The East Asian economic miracle is all about the state in control of the banks (printing).

Read Quest for Prosperity -- the private/public construct of distinction is a complete myth that is exposed by the titans in Asia and Latin America. The more we stick to the myth in the US, the longer it will take for us to have the same degree of success. Innovation comes not out of motive for profit, but ou of need and desire and capability.

pdog• 14 years ago

We already know how. The political will just isn't there.

alexqgb8• 14 years ago

Bullshit. If you're talking about the American people, the political will is there in spades. But thanks to gerrymandering and the filibuster, their voices been successfully nullified. The GOP holds the House by a wide majority, even though their members in it received fewer votes than the "minority" in opposition. And while the GOP has a numerical minority in the Senate, they still control the chamber since it (alone in the developed world) runs on a self-imposed Supermajority rule, not a simple majority.

These two departures from basic democratic control have freed the legislative body from proper accountability to the people, rendering the will of the people increasingly irrelevant to the operations of the government. Saying political will "is just not there" like this is some sad but immutable fact of life ignores the reality of the situation: America has suffered an unofficial coup. We are now suffering under an intrinsically illegitimate government that preserves its power thanks to very clear, very precise structural problems that have been magnified enough to effectively hinder the legitimate will of the people.

These are facts, and they are neither debatable nor acceptable. The situation must resolve itself and it must do so in favor of the people.

tokipin• 14 years ago

http://www.fairvote.org/electoral-college-chaos-how-republic...

http://rslc.com/_blog/News/post/REDMAP_2012_Summary_Report

yummyfajitas5• 14 years ago

Vote totals for the bailout:

Aye: 171 D, 91 R. Nay: 63 D, 108 R.

http://www.opencongress.org/bill/110-h1424/show

Why are you complaining about the GOP holding the house? Based on their votes, they seem to be the party of letting banks pay for their mistakes.

rwmj• 14 years ago

I'm confused by this. The large banks are (arguably) more efficient because of economies of scale, eg. less duplicated management, purchasing power. So it's probably not a good idea to limit the size of banks which is what this article seems to propose, because that'll make banking more expensive.

But the flip side is: why don't we just let megabanks go bust? If they go bust, the government steps in, briefly nationalizes them, sells off the parts (the shareholders get nothing, of course), and life continues. As long as this period is kept as short as possible why is there any danger of "meltdown"?

CJefferson• 14 years ago

The sums of debt some of these banks got into swamped their share value, and in some countries were a fair chunk of the GNP. But I certainly wish we had removed shareholders from any bailed out bank.

One issue is some banks were on the border on if they needed bailing out, and shareholders might prefer the risk of catastrophic failure than taking a bailout which would lose them their shares.

zevyoura• 14 years ago

Temporary nationalization of banks was suggested in 2008, but the idea is not politically viable on the right in the US.

ataggart3• 14 years ago

Per the article, size is correlated with problems but not the cause of them. It happens that large banks are the ones who are more likely to get bailed out, thus they are incentivized to take more risk, so they do. It is the potential for government bailouts/protections that is the root of the issue, thus the proposal is basically to stop doing that.

aaronblohowiak• 14 years ago

The problem is not the bailout, per se, the problem is that the bailout didn't wipe-out shareholder value (and executive compensation) in the process.

Lambent_Cactus• 14 years ago

"the government steps in, briefly nationalizes them, sells off the parts (the shareholders get nothing, of course), and life continues"

That's the solution I would have preferred in 2008, but the political system has shown it can't commit to that solution. You lose any support for that resolution plan from conservatives at "briefly nationalizes", because they're afraid any nationalization won't turn out to be brief at all. So nationalization is off the table, and we have to stumble through with bailouts.

svachalek2• 14 years ago

Your first argument rests on the idea that they will pass those economies of scale on to consumers, which I have never found to be the case. In my experience, smaller banks are consistently more competitive; they pay higher rates, charge lower rates, and have fewer fees.

rayiner3• 14 years ago

It's like asking why we don't let a structurally unsound skyscraper just go bust. Not a problem in isolation, but not really safe in the midst of a crowded city block.

RockyMcNuts4• 14 years ago

If you do that you're still subsidizing banks. The simple act of telling creditors that if the banks gets into trouble the government will step in, wipe out shareholders and keep depositors and creditors whole, makes credit more available to them. Of course I'd rather lend to a bank with that kind of backstop than a small savings bank/credit union.

And then if I'm a bank manager, I'm going to borrow as much as possible, and do a lot of high-risk, high return type trading, if it works out I make a ton of money, if I lose it's the government's problem.

Finally, it's not that likely for a Treasury official to tell a TBTF bank they're taking it over - it's an administrative nightmare, and the banks have captured the regulators.

So if a bank gets weak, markets will keep extending credit as long as there's a government backstop, and it won't get taken over, and management will keep playing double or nothing with taxpayers' money.

kzrdude• 14 years ago

We have a structural problem, when things are "too big to fail", the normal democracy does not work anymore, the bank gets too powerful on its own and goverments can't regulate it effectively.

Moreover, bigger companies are not necessarily more efficient. A smaller company (or country) has the agility of a shorter decision chain.

rtpg• 14 years ago

It costs a lot less to save a small bank than a big bank, and the risk is spread out over multiple organisations. If we had (for example) small banks that were more specialised, if the housing market falls through, those sorts of investment banks would disappear, but others should stay relatively untouched. That was the whole point of Glass-Steagal : if the investors mess up, at least make sure that we don't have to wipe out Grandma's savings.

flyinRyan• 14 years ago

>The large banks are (arguably) more efficient because of economies of scale, eg. less duplicated management

Someone has never worked in a large bank before.

druswick• 14 years ago

Another interesting way to think about "too big to fail" is as a considerable government subsidy. Banks operate in a risky environment. When there's a meltdown, the government steps in to bail the largest banks out. These banks are getting a free insurance policy from the government, a subsidy that's not going to the smaller banks.

noibl• 14 years ago

The word 'meltdown' is apt.

[Price–Anderson Nuclear Industries Indemnity Act] http://en.wikipedia.org/wiki/Price%E2%80%93Anderson_Nuclear_...

rumcajz• 14 years ago

The proposal should be extended to all "too big" companies.

Big companies combine the worst characteristics of state-owned and privately-owned enterprises.

On one hand, large amount of small shareholders makes them similar to state owned companies (in which everyone is a shareholder) with all the associated bureaucracy, parasitic management class, pathological incentives etc.

On the other hand, being private they lack even the weak control mechanisms that democratic societies impose on state-owned companies.

knodi• 14 years ago

The banks will never let this happen. The banks have become too powerful.

charonn02• 14 years ago

My first reaction to hearing the term "too big to fail" was "then make them smaller." I'm surprised that it's taken this long for such an idea to be seriously considered.

charonn02• 14 years ago

The criminal actions[1] of Wachovia, Lloyds, Credit Suisse, Barclays, HSBC, et al have shown that the megabanks cannot be trusted to follow existing laws.

The robo-signing debacle[2] has demonstrated amply that the financial sector can't be bothered to verify their data before destroying the lives of thousands of people.

The LIBOR manipulation scandal[3] proves that even the industry's own measuring rods are bent and unreliable.

The last 5 years have revealed an industry rife with crime, deceit, and unabashed greed which has severely damaged the global economy and the quality of life for hundreds of millions of people. And the penalties for these actions pale in proportionate comparison to those imposed on a street-level drug dealer.

When a private enterprise becomes too essential to regulate effectively, it endangers the society in which it operates. Breaking it up into manageable chunks is the only viable option.

[1] https://www.nytimes.com/2013/01/03/opinion/how-bankers-help-...

[2] https://en.wikipedia.org/wiki/2010_United_States_foreclosure...

[3] https://en.wikipedia.org/wiki/Libor_scandal

snitko4• 14 years ago

I always remember what Milton Friedman used to say, he was amazed be people who see failure of regulation and propose a fix by seeking to introduce even more regulation.

"well this time it will surely work!" "if only we had the right kind of regulation/people in charge!" they say.

That's never gonna happen. Breaking the system in chunks artificially will not work, because it will consolidate again and buy up the regulators. The true solution here is Bitcoin, precisely because it is not controlled by anyone.

lwat2• 14 years ago

I used to be an Austrian but it's been almost a century now and it's become clear to me that the Keynesians are actually correct. Even after the GFC things bounced back very quickly. The power to inflate away old debt is too useful to sacrifice.

dalke• 14 years ago

You see this as a "failure of regulation"? I see it as a failure of deregulation. We passed laws and made interpretations which reduced the effect of structural safeguards in the financial system. We didn't pass laws which strengthened those safeguards or improved oversight.

As for "manageable chunks", vs. "artificial" chunks, I point you to this comment by Alan Greenspan, in http://www.freepatentsonline.com/article/Brookings-Papers-Ec..., that the current size is too large, and not manageable.

> For years the Federal Reserve was concerned about the ever-growing size of our largest financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest size (Berger and Humphrey 1994, p. 7; see also Berger 1994). A decade ago, citing such evidence, I noted that "megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail" (Greenspan 1999). Regrettably, we did little to address the problem.

> ... However, should contingent capital bonds prove insufficient, we should allow large institutions to fail and, if assessed by regulators as too interconnected to liquidate quickly, be taken into a special bankruptcy facility, whereupon the regulator would be granted access to taxpayer funds for "debtor-in-possession financing" of the failed institution. Its creditors (when equity is wholly wiped out) would be subject to statutorily defined principles of discounts from par ("haircuts"), and the institution would then be required to split up into separate units, none of which should be of a size that is too big to fail. The whole process would be administered by a panel of judges expert in finance.

This is based on issuing contingent capital bonds, which funds a "living will" "in which financial intermediaries are required to offer their own plans to wind themselves down in the event they fail."

alexqgb8• 14 years ago

Extending this theory to the world of software it would make it foolish to update or iterate or anything, because thanks to the passage of time, you're just going to have to update and iterate all over again again.

On the other hand, rejecting idiocy like this gets us from Astrology to Astronomy, from Alchemy to Chemistry, and the Magna Carta to the US Constitution, and further, the amendments to it.

stretchwithme• 14 years ago

The real problem is that they are successful in duping governments to underwrite the risks they take. And they LEGALLY influence legislators to rewrite laws so they can LEGALLY take more risks. And when things blow up, they LEGALLY influence them again to get bailouts.

The incidents you cite above happened to exploit the fact that there is someone who will absorb all the risks of otherwise unprofitable practices.

hcarvalhoalves• 14 years ago

Give me a break. The whole point of the banking system is to concentrate capital into a handful megacorps. When you have thousands of little competitors, profit plummets and risk increases enough to make banking not a viable business anymore.

Heck, that's how banking started. A handful Venetian traders got so rich they started lending money.

maeon3• 14 years ago

If we call for BitCoin as the solution, The Federal Reserve will fight us, using our money, to make it the villan in the narrative. If we call the division of banks as the solution, the federal reserve will support it, because gigantic entities have clout in resisting the parasitic nature of the Federal Reserve, where minor banks would have to suffer what they must.

Whatever we do, the parasites who can print and dilute our currency through systematic inflation must be appeased and satisfied, or else they will inject poison into the entire system as a retaliation for trying to remove the blood sucking parasite. The bitcoin angle won't work.

How to cut megabanks down to size

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