[Wow. I wrote the rest of this post between Tuesday and Thursday, to go up Saturday. Friday’s Wapo has a very long front-page story on the influence of donors on the agenda at the Brookings Institution. Martin Baily and Doug Elliot, listed below, are with Brookings.]
Financial regulation experts said Tuesday breaking up large banks could be costly while offering no additional safety-benefits for the economy.
I was on the panel at the Bipartisan Policy Center, and I argued in favor of breaking up big banks, but I am not mentioned in the story.
The panel was called to discuss a research paper commissioned for the Center and written by Martin Baily, Doug Elliot, and Phillip Swagel. The paper says that (a) we have little reason to worry about too-big-to-fail, because the FDIC is on its way to having enough authority to resolve big bank failures, (b) there are economies of scale in banking at the very highest levels, (c) there are transition costs to breaking up big banks, in that employees and customers would be left hanging waiting to see how the re-org falls out, and (d) breaking up big banks would not get rid of systemic risk, anyway.
I agree entirely with (d). I thought that (c) was a fair point, but there is such a thing in the corporate world as a spin-off, and it can be done. I disagreed with (a) and I was unpersuaded by (b).
I was invited to a pre-panel breakfast. However, when I got there, I soon felt out of place. Part of it was that the breakfast sandwiches were not what I would eat for breakfast (or any time). Another part of it was that the setting was larger and more formal than I had expected. Instead of a few panelists milling around, it was an executive conference table, and Elliot, Swagel, and I were the only panelists there. The rest of the approximately fifteen men (plus one woman) around the table were from trade associations (such as the American Bankers’ Association), except for two from Bank of America.
So I excused myself to go to the bathroom, got back on the elevator, went downstairs to a cafe next door, got a little food and tried to collect my thoughts. I discarded most of my talking points, which had been focused on left-vs.-right issues in narrating the financial crisis and financial regulation. I tried to come up with something appropriate for an audience of bank lobbyists.
When I got back upstairs, the breakfast was still underway. Elliot and Swagel proceeded to give the main points of the paper, with the K street folks nodding in approval. Elliott made a crack about not being able to persuade opponents who refuse to be persuaded by evidence, and I was the only one who didn’t laugh. Meanwhile, I perused a copy of the annual report of the Bipartisan Policy Center, because it happened to be on a shelf behind my seat. I thumbed through the annual report, looking for its list of donors. I cannot say that I was surprised to find in that list Bank of America, the American Bankers’ Association, etc.
A few minutes before 10 AM, the rest of the panelists assembled. I asked Baily, as an expert on productivity statistics, whether he thought that any economist would claim to have a reliable measure of bank output. “Of course not,” he replied, nearly breaking into a laugh. I was glad to hear that response, because it reinforced my view that econometric estimates of scale economies in banking are not reliable. When you measure economies of scale, you are comparing the ratio of output to inputs at different-sized firms. It’s rather difficult to do that if you cannot measure the numerator.
Then came the panel. I was a bit embarrassed to be in a chair with no desk in front of me. I was wearing high-topped gym shoes, in order to lessen a mild but nagging foot injury.
No panelist made a prepared statement. Instead, we were each given prompts by Neil Irwin, who writes for the New York Times, and who tried to be fair to all of the panelists. Watching the tape, I think that my share of time was reasonable–more than Swagel’s although probably not as much as Elliot’s.
The fourth panelist was Marcus Stanley, who pushed for a more top-down, regulatory solution, with the government trying to once again split retail banking from securities trading. I disagreed with that approach.
In response to Irwin’s first prompt for me, I tried to say something like the following:
From 1980 to the present, our largest banks went from teeny-tiny banks to super-sized banks. I would like to dial them back to what I might call Goldilocks banks. I have three tests for that.
1. The Great Day test. Imagine that an official in Washington gets a call from the CEO from the nation’s largest bank requesting to meet right away, and the official says, “Take a number like everyone else.” It will be a great day when that happens.
2. The “Take my lumps” test. Suppose that you buy shares of stock or bonds issued by the nation’s largest banks. I want you to say, “If that banks gets into trouble, I’ll just have to take my lumps.”
3. The Dry Underpants test. If the Treasury Secretary and the Fed Chair learn that the largest bank in the country is toppling, they should be able to keep from wetting their pants.
I don’t have a precise number in mind, but if today’s largest banks have $2 trillion in assets, then I think that something like $200 billion might work.
On the issue of economies of scale in banking, I tried to make the point that the estimates cited in the paper are not reliable. I then pointed out that the largest banks did not get big on the basis of focused excellence. I said that I understood how Intel got big and how Walmart got big. Instead, it took 37 mergers to create JP Morgan Chase, and 50 mergers to create Bank of America (I didn’t cite my source, which was Wikipedia.)
Near the end of the panel, I lobbed a grenade into the room. I suggested that one issue with breaking up the largest banks is that there are large banks in other countries that might take some of the business. I said that maybe that would be a good thing, because it might be that America does not have a comparative advantage in large-scale banking. I said that we have a poisonous relationship between big banks and regulators. Also, we don’t have executives who think of themselves as part of a continuous tradition that they inherited from the past and want to pass on to the future.
Afterward, I found myself with a lot of negative feelings. In my mental replay, the morning breakfast became a gangster movie in which I was the gangster who walked into a set-up, with the boss of a rival mob having packed the joint with his muscle.
I started to imagine a revised version of the “Great Day” test.
It will be a Great Day when the nation’s largest bank does not spend money on getting economists to write a paper that extols the benefits of super-sized banks and the costs of breaking up such banks. It will be a Great Day when it does not spend time, effort, and money trying to attract the press to a pseudo-event. And it will be a Great Day when I feel like somebody invites me to an event because they are interested in what I might say, rather than feeling like I was used as a free prop in their policy theater.
Not that I wish I had said that. I’m still trying to sort out my feelings. A few more random thoughts:
1. Baily, Elliot, and Swagel are as sincere in their beliefs as I am in mine.
2. To the extent that this event was a PR stunt paid for by big banks, they may not have gotten their money’s worth. Apart from Garcia’s article, it seems to have been ignored. It might have gotten some coverage if former Senator Ted Kaufman had appeared. He was originally invited to be on the panel, but he backed out about a week before. He probably knows how the game is played.
3. If bank-bashing only ends up boosting support for the Elizabeth Warren types, then I am making a big mistake by bashing big banks.
Ha I used to work at BPC and they’re not bad people there. You weren’t being set up. I’m not sure what the donors think they’re getting, but I think the relationships (especially with people like Daschel and Domenici) are a form of insurance.The donors don’t know what they want exactly, but they want to have the relationships in place in case Maxine Waters ever runs the banking committee. Giving a few bucks every year is more important than giving a lot of money yesterday.
Thank you for another superb piece containing indispensable thoughts from a brave man with a wonderful sense of humour. He who is open to your good thinking can only benefit from it, the rest must suffer.
Arnold:
Thank you for this.
I hadn’t watched the actual video until today. But I had read their published paper at the time of your first post on this topic. (I was not impressed by their paper, as my comments to your first post reflected.)
One question …
You noted that “big banks” got “big” by way of mergers, as opposed to “organic growth” – and that is a valid point. During the discussion, Mr. Elliot countered your “big through mergers only” perspective. Were you at all persuaded, or even influenced by his counter-argument?
As an aside to my question, I consider you to have a fairly high “geek quotient”. I found it interesting that Mr. Elliot prefaced his counter-argument with a bit of his own professional history at J.P. Morgan, thereby indicating his “geek quotient” is also very high.
The question is this: what can you do with a $2 trillion portfolio that you cannot do with a $250 billion portfolio. The only answer seems to be that you cannot lend as much to facilitate very large corporate mergers. I am willing to see American banks give up that capability.
As an aside, I think of a geek quotient in terms of understanding of derivatives, and he struck me as more on the mergers-and-acquisitions side of things. I could be wrong.
Wouldn’t the question be better posed as what can one $2 trillion bank do that eight $250 billion banks cannot? If the super giants are still participating in loan syndicates today I don’t see what would be different if there were 10 times as many merely giant banks and no super-giants. But in Barbarians at the Gates, they do highlight that there are only three US banks capable of doing the merger financing and by strategically locking them up one of them the number of possible acquiring firms is reduced. I think the largest syndicated loan of all time was the Verizon one last year which ran $61 billion, which seems pretty small relative to the size of the balance sheets of the giants.
Global activity seems a more plausible justification than M&A. A $250 billion bank trying to be full service to global multinationals might be $80 billion in the USA, $80 in the UK, $30 in the EU, $20 billion each in China, Japan, and Singapore, which is a lot different than a $250 billion bank operating solely in the USA. At that sort of scale difference there really might be a problem doing some projects. But even then I have trouble thinking up what.
The problem is that that’s not how syndicates work.
When a new loan is being proposed, a “lead” bank will negotiate with the client and then underwrite the entire facility and take all of the risk up front.
They will then in turn invite syndicate partners to participate in the loan that they’ve already funded based on each partner’s interest and desired level of exposure.
So, for your example of 8 $250B banks, versus one $2T bank, if you have an M&A loan for $10B, that will be 4% of the smaller bank’s balance sheet, or 0.50% of the larger bank’s balance sheet.
I can guarantee you that those $10B loans will have a lower likelihood of being completed with smaller banks because that 4% exposure will be unjustifiable and cause each bank’s credit risk department to have heart palpitations and so no one will take the up-front risk of that initial $10B exposure.
The FRBNY has published several papers on scale economies in banking that may be relevant for you:
The impact of network size on bank branch performance
http://www.newyorkfed.org/research/economists/hirtle/branching_paper_JBF_Final.pdf
The Performance of Universal Banks: Evidence from Switzerland
https://ideas.repec.org/p/szg/worpap/0103.html
The consolidation of the financial services industry: causes, consequences, and implications for the future
https://www.fedinprint.org/items/fedgfe/1998-46.html
Diversification, size, and risk at bank holding companies
https://www.fedinprint.org/items/fednrp/9506.html
Leaving the breakfast to go eat somewhere else, perusing the report, wearing the high-tops: geek cred undisputed.
The fact that I was laughing at your account when, judging by the facts alone, I should have been crying, or at least sighing gloomily: is there such a thing as a stealth humorist? I’d actually like to see a movie version of this and some other incidents in your life (e.g. Congressional testimony). With editing, voiceover, and subtitles to translate what’s being said to what’s actually meant, it’d be a hit somewhere out on the long tail.
(I actually thought your reference to the “Bipartisan Policy Center” in a later post was fictional. It may actually be funnier now that I know it’s not….)