Nobody asked me. Instead, they asked Ben Bernanke and other usual suspects.
Bernanke criticized the notion that a breakup of large financial firms will promote financial stability, or mitigate excessive risk taking. In his remarks, Bernanke argued that in addition to the social costs, size also has benefits when it comes to banking. “In the long run, a US financial industry without large firms will likely be less efficient,” he said.
Pointer from James Pethokoukis. I like the way I expressed it in this post.
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.
During the crisis of 2008, the banks were big enough that Bernanke and Hank Paulsen failed all three tests.
Note that I do not claim that breaking up big banks would do anything for financial stability. What I see it doing is giving big banks a bit less leverage with policy makers and giving taxpayers a bit more leverage with them. To me, that is enough of a win.
“Note that I do not claim that breaking up big banks would do anything for financial stability.”
I am not a fan of letting Bernie Sanders or Elizabeth Warren or any Republican lawyer “break up” banks (because they would of course figure out the one worst way to do it). However, if inflating money (banks do that) and then investing it in speculative assets (banks do that) causes prices to rise (banks do that to) and that makes those speculative investments look like good investments, doesn’t just having more managers managing make it less likely to have large piles of money pile into a speculative bubble? I’m “on record” as being skeptical of breaking up the banks, perhaps in part because I assume it’s just an idle threat that will be dusted off whenever the politicians want something, but I can easily see some instant benefits.
Seems like breaking up the largest banks could pass test #1, but not #2 and #3. The head of the largest bank might no longer be such an important figure, but — as in 2008 — if the largest bank is facing insolvency, wouldn’t the odds be in favor of the others in the top 10 finding themselves in similar straits? So, the treasury secretary and fed chair would still be wetting themselves not because of the effects of the failure of the largest bank itself, but because of expectations of a cascade of failures. Or don’t we think there would have been herd behavior among a hypothetical set of not-so-big banks in 2008 and that they wouldn’t have all made the same decision to bulk up on ‘AAA’ mortgage backed securities?
They were for letting Lehman go before they were against it. They thought they were in moral hazard town when they didn’t realize they had missed the turn and were really in impending crashville. Which is odd, considering they are the one group never held accountable for mistakes, why didn’t they attempt to play it safer? Maybe that IS why.
Herd instinct indeed.
People seem to forget the last major case of financial fraud, the S&L crisis, resulted in almost 1/3 of the S&Ls in the country failing.
While I do think there is a limit to how big a bank can be, it is certainly not the most important part of stabilizing the financial sector. IMHO, that would come from bringing the shadow banking system under regulatory supervision.
I realize people keep saying that. Then I finally started thinking “why?” (And remarkably not the exact moment Paul Krugman said it, but in hind sight, it should have been). Now I tend to believe the regulatory regime causes the shadow banking system.
Yeah, cause policemen cause crime and firemen cause fires.
I find contradictory that economist that normally love large companies are so concerned with the size of banks. For the most part the bank and financial institutions grew by the free market from 1980 – 2006.
Secondly, there several big players that did disappear in 2007 and 2008.
The last point, was all the banking institutions in 2008 were failing at the same time. There was no pick a number stuff because there was Lehman, Fannie, Freddie, Merryl, Citibank, WaMU, Wachovia, AIG and possibly BofA and GE. Pick a number sounds good in normal times (ie It looks like Lending Tree is picking a number and we can easily close it) but the fall of 2008 was not normal times.
End Federal deposit insurance; then deal with the failure of a big bank through monetary policy (if *any* governmental response is needed). No need to break up the big banks.
The advantage would be the Fed could let the first fail before intervening on the rest without needing congress involved, not that they would not have to intervene before the entire interlocking industry collapses. Only they are capable of preventing that.
YES – break up the biggest banks.
How?
Thru progressive capital requirements: (end state) for banks with less than $100 billion in assets, same capital requirements as now, for banks with $600 billion or more, a 50% capital adequacy ratio requirement. (CAR is now 4% for shares, 8% for total capital risk adjusted).
This could be phased in over 50 months in 5 years (excluding Dec & Jun, 10 months per year of changes), or thru other phased in approaches.
The “Big Swinging Dick” syndromes in the big banks will be less extreme.
The willingness of the third biggest, or 33rd biggest, to try different strategies will make more big banks take notice of such different strategies. The total profits to the financial sector are much more likely to go down, with those 13th or 23rd biggest really just about as able as the top 3 to do every deal, and willing to do so for less.
This is also an issue in Big accounting firms; from Big 8 down to 3? But their failures are systemically important.
Getting rid of deposit insurance is fine, but it is not the problem, especially considering avg voter/ depositor ignorance.
(In fact, perhaps the biggest problem of Lib free markets is the need to be not-ignorant in so many areas, and lazy folk, like me and most, don’t want to have to be so careful all the time.)
All the Big Banks (TBTF) should have gone thru a gov’t bankruptcy cleansing out of their share capital and cancelling of all bonuses for the top managers, with temporary bankruptcy wages for the those who aren’t fired, but stay. (down to prior year’s Avg taxpayer wage, ~$50k, or a cut of 10%, whichever results in lower wage).
Big Bank failures are systemically important, the accounting firms are not.