A reader writes,
I would describe the posture of big banks (and other well-heeled financial institutions) as “pleading for mercy,” more than “buying friends and influence.” Banks are giant piles of treasure and if in the olden times they would send hordes, spells and dragons, now they send the DOJ, regulators (state, fed and quasi-public, like FINRA) and the plaintiffs’ bar.
Big banks are subject to shakedowns by grandstanding government officials. But I think that in exchange for paying this “tax,” big banks get enough benefits from government that they are better off big.
I do not believe that there are economies of scale in banking at such high levels. We do not see banks get large organically. They get large through mergers. The result is to create institutions with very high levels of operational risk, because senior management cannot possibly keep track of what the various units are doing. But if one of the units messes up, the taxpayers are there to provide a bailout.
1) In reality, it was the medium size banks or investment banks that were the worst offenders. not the largest one. In the case of the largest ones, only Citi really was that borderline survived if you assume BofA was sort shotgun to take Meryll Lynch.
2) Haven’t most long time businesses consolidated a lot the last 30 years. Grocery stores or airlines. The economy has naturally moved this direction with most long time businesses.
3) Historically the US has been the developed world oddball with a heavy local banking presence.
4) In terms of the S&L crisis there was bailouts and lots of failure of small institutions. In fact the government probably wrote a bigger check on that crisis than the 2008 Housing Crisis despite being significantly smaller.
Regarding point (4), the bailout cost the taxpayers $150 billion. Even adjusting for inflation, the bill for the financial crisis was quite a bit higher. Also, most of the cost of the S&L crisis could have been avoided had the regulators not relied on “extend and pretend.” The S&L business model was destroyed by inflation in the 1970s, but most of the clean-up did not take place until a decade later, by which time the losses had multiplied.
Regarding point (3), this is very much a plus for the United States in my opinion. We have the best developed stock markets and venture capital market in the world in part because until the 1980s our banking system was unusually fragmented. There is a decent argument (made most strongly by Calomiris and Haber) that our banking system was too fragmented historically, but by now I believe that our banking system is too concentrated.
Regarding point (2), there are industries where firms grew to dominate because of superior execution and/or economies of scale. That is definitely not how the top banks in the U.S. became large. They got big through mergers. And through all sorts of regulatory barriers to competition.
Moreover, in other industries there has been new entry. The competition in groceries in recent decades has been very intense. Airline competition has been more uneven, but still there has been much more entry than in banking, even though the fixed cost of getting an airline operating would appear to be much higher than the fixed cost of opening a bank.
Regarding point (1), I do not claim that big banks are inherently riskier or more poorly run than smaller institutions. My main problems with big banks are:
1. Their CEOs have immediate access to key politicians.
2. Money managers who lend to banks have to multiply the probability that the bank is/becomes insolvent times the probability that it will not be bailed out. For small banks, the second probability is not high, because the FDIC tries to resolve these banks with mergers, and that leads to excess willingness to lend to those banks. But for small banks, the second probability is exactly zero, and that distorts behavior even more.
3. In a crisis, the big banks are certain to receive bailouts. The CEO of a big bank can expect huge rewards for success, or even for mediocrity, with no accountability at all for failure. How could the rest of us not feel angry about that situation?
(My) attempted start at a taxonomy of the issue by separating the components
(A) Moral Hazards and the likelihood of booms
(A.1) Why do banks grow? Non-competitive advantages big banks have for growth.
(A.2) Systemic importance relative to size (small banks might have cascade failures, but one mega-bank is TBTF).
(A.3) Political favoritism
(B) Severity of the bust
(B.1) Likelihood of correlation of size and failure and correlation of assets with big banks versus greater diversifiction with small banks.
(B.2) Likelihood of the bailouts to be centered on the big banks (justified as trickle-down) versus attempts to support smaller entities from the bottom up. E.g., do we have a jobless recovery because not much more than saving the banks was attempted, banks who probably extracted wealth from consumers to shore up their own balance sheets?
2) Most consolidation of markets were from mergers and acquisitions with some degree of stronger and economies of scale. We have seen a Grocery stores brands disappear a lot the last thirty years and most of them were mergers and investors decided to sell out. And I bet that was true with a lot mergers of banks in 1980 – 2003. Also in terms of economy of scales, isn’t there ATM and branches give the big banks a lot of benefit here? Also bank economy of scales makes investor more willing to give money at a .15% lower rate. At this point, if one large bank was close to failing(instead half of them), the Fed could close it down correctly. Overall, I don’t see why the bank mergers or grocery store mergers were significantly different outside investors making more and CEO bonuses.
4) Quite honestly, I have never seen a price tag on TARP as most of the companies paid the money back by 2012 where as S&L was a direct check $140B (closer to $260 inflation adjusted). Throw in AIG and Frannie/Freddie I would like to know to the exact price tag. Otherwise, I do tend to agree the post S&L system was stronger than the post-TARP system.
3) We forgot how ridiculous how fragmented the banking system was 1980. It was a Depression era religion. Then at period from 1980 – 2010 was the optimal?
And in terms of competition, maybe the feds should allow Wal-Mart or, say, Apple/Google enter banking.
The government bond market, the ten year rate is rigged by the big banks so that the Senate does not go way off budget. It is a necessity because there is one supplier of debt, Congress. Congress could never budget without the big banks conferring on klikely rates and charges.
I don’t understand the claim that the 2008 bailout cost $150bn. Hasn’t the government recorded a net profit on the bailouts? https://projects.propublica.org/bailout/
And this doesn’t count the massive criminal penalties paid by the banks?
tiny typo “small” twice, second time should be “big” as contrast in #2:
“For small banks, the second probability is not high, because the FDIC tries to resolve these banks with mergers, and that leads to excess willingness to lend to those banks. But for small banks, the second probability is exactly zero, and that distorts behavior even more.”
The country is much better off with a couple of thousand medium sized banks whose CEOs are millionaires, rather than a thousand mediums plus a dozen huge banks with multi-millionaire (billionaire?) CEOs.
Part of the stagnation has been too few loans to start-ups and new entrepreneurs — more medium banks would be competing more for that business.
The mergers of the big banks are not helping consumers, nor most employees. Probably it could be shown that part of the stagnation in banking worker wages is that there are fewer competing banks, tho I haven’t seen data on this. The top wages go up disproportionately.
I remain enraged at the TARP bailouts for the big, irresponsible TBTF banks. There would have been a stronger recovery with more big bank failures and rapid restructuring and ending of big bank bonuses.