Should We Break Up the Big Banks?

 

Over at Red State, Eric Erickson writes:

I hope the Romney campaign seriously takes on this idea. We have created a financial situation in this country, with Dodd-Frank and other policies, that have stacked the banks against the American people. They have become so massive that they can do pretty much what they want because they can hire all the lobbyists they need to get what they want from Washington and if they falter or fail, the nation goes belly up.

It is absolutely a conservative imperative to break up the big banks. Conservatism should eschew public-private partnership at this level. The banks have, in effect, become an extension of the government in that they now exist in a wholly symbiotic and unhealthy relationship with Washington. If we want smaller government, we need smaller banks too.

I am inclined to think that he is right. My instinct is that banks that are too big to fail cannot properly be regulated — that, given their size and influence, regulatory capture is inevitable. That is what happened with Fannie Mae and Freddie Mac. Paul Ryan, John McCain, and others sought to rein them in, and their attempts were overwhelmed by the lobbying efforts of these two outfits. And what I have read suggests that TARP was largely designed by the big banks and foisted on the Bush and Obama administrations.

But presumably something would be lost if we broke up the biggest of our banks — efficiency, perhaps, and leverage. I have not, however, studied these matters with the requisite attention. What am I missing?

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  1. Profile photo of Paul A. Rahe Contributor
    Paul A. Rahe Post author

    I write from a Honda dealer in Hagerstown, Maryland. Soon, I hope, we will be back on the road, heading home. I probably will be unable to respond to comments. My apologies.

    • #1
    • August 22, 2012 at 6:36 am
  2. Profile photo of ConservativeWanderer Inactive
    Paul A. Rahe: I write from a Honda dealer in Hagerstown, Maryland. Soon, I hope, we will be back on the road, heading home. I probably will be unable to respond to comments. My apologies. · 0 minutes ago

    Honda dealer? “[B]ack on the road”? That doesn’t sound good.

    • #2
    • August 22, 2012 at 6:38 am
  3. Profile photo of Last Outpost on the Right Thatcher

    I don’t like the idea of a government regulator deciding who is “too big” and who isn’t. I doubt they’d ever get it right on purpose. If a bank that’s huge fails, then lots of consumers get hurt (maybe even me). But when that happens, other consumers will stay away from “big” banks, creating an opportunity in the market for creating ever more “small” banks.

    • #3
    • August 22, 2012 at 6:41 am
  4. Profile photo of BrentB67 Inactive

    The argument I have heard for not breaking up the big banks (Please note I do not subscribe to this argument) is that it would make our banks much less competitive globally in the Over-The-Counter derivatives markets. This raises the question – is it in our nation’s best interest for our banks to be leaders in this market, that is another debate?

    Globalization has increased the need for cross-border hedging of financial, commodity, and other transactions, but it is hard to tell where we go from useful hedging and speculation and get into malicious finacial warfare in these opaque markets.

    I think a better argument is limiting what kind of transactions a bank may undertake if they have FDIC guarantees on their depositor’s funds. Mortgage held on their balance sheet, U.S. Treasuries, auto loans, credit cards, business loans for depsitors, floor plans, etc. are a good start to acceptable practices. I do not think that Greek credit default swaps, or CDS index hedging, etc. are acceptable practices for FDIC insured banks.

    • #4
    • August 22, 2012 at 6:47 am
  5. Profile photo of Keith Inactive

    No matter the consequences, the banks should be left on their own to fail or thrive without government help. It’s the principle of the thing. The Rule of Law and the principle of Equality of Opportunity demand it. For the same reasons, the Federal Reserve should be abolished. Let the government run the military by taxation, let the banks exist by paying reasonable interest on savings and making quality loans. If we keep a fiat money supply, peg money injection to the deflation in prices of a basket of goods, and send money to taxpayers based on their income taxes paid (before deductions) so the taxpayers get the first and best use of new money.

    • #5
    • August 22, 2012 at 6:47 am
  6. Profile photo of Barkha Herman Member

    No, “we” shouldn’t. But we should let them fail when they mess up.

    • #6
    • August 22, 2012 at 6:47 am
  7. Profile photo of FloppyDisk90 Member

    “Regulatory capture” is a concept given to us by economics.

    • #7
    • August 22, 2012 at 6:49 am
  8. Profile photo of BrentB67 Inactive

    Good points from Keith and Barkha. The most important thing we need to do is stop socializing the losses any bank incurs and install an FDIC firewall.

    • #8
    • August 22, 2012 at 6:50 am
  9. Profile photo of Mel Foil Inactive

    Big banks are probably needed for big mergers and acquisitions. You can combine forces to do it, but that also makes it harder to negotiate the deals in secret. And I imagine, we are competing with banks in other countries too. If we could just have some confidence in their balance sheets, that would go a long way. The problem in 2008 was, they were lying to everybody about their assets.

    • #9
    • August 22, 2012 at 6:55 am
  10. Profile photo of Sumomitch Inactive

    The banks “too big to fail” in 2008 are all much bigger now, thanks to the Fed-brokered mergers with failing institutions, and the perception by the public that one’s deposits are safer with any institution that got bailed out in 2008 than one which did not. As with Fannie and Freddy, once the US guarantee is percieved by the market, we are no longer dealing with natural market forces balancing risk and rewards to expansion. Same with risky derivatives and other “Whale” trading positions: the normal caution that arm’s length counterparties might employ in limiting their exposure to a single party no longer operates as a market constraint on risk such institutions or their traders can take on. (Of course, the Jamie Dimons and Jon Corzines of the world always see themselves as Masters of the Universe maximizing risk to maximize profits and bonuses, until the trades go bad and the Fed “put” needs to be utilized.) By all means, let’s break up the 2 Big 2 Fail institutions; but what to do about the Fed that created and sustains them? That, unfortunately, is the question only Ron Paul asks, and is labeled crazy for asking.

    • #10
    • August 22, 2012 at 7:04 am
  11. Profile photo of flownover Inactive

    If we pulled the government security blanket away and let the market be the regulating factor, wouldn’t this work itself out ?

    All of this government meddling and throwing taxpayer ( The Ultimate OPM) money around like a drunken Zeus is the problem, as that meddling part has become the raison d’etre of the majority of the Federal Government these days. 

    The hardest part will be prying that power away from the government, not prying the banks off the government teat.

    • #11
    • August 22, 2012 at 7:30 am
  12. Profile photo of MBF Member
    MBF
    Last Outpost on the Right: If a bank that’shuge fails…
    Keith Bruzelius: No matter the consequences, the banks should be left on their own to fail or thrive without government help.
    Barkha Herman: No, “we” shouldn’t. But we should let them fail when they mess up. · 34 minutes ago
    BrentB67: The most important thing we need to do is stop socializing the losses any bank incurs ..

    What are the realistic odds of DC politicians letting these banks fail? Haven’t we already seen how this plays out?

    • #12
    • August 22, 2012 at 7:34 am
  13. Profile photo of Keith Preston Member

    it worked with standard oil…let’s do this.

    • #13
    • August 22, 2012 at 7:37 am
  14. Profile photo of Lucy Pevensie Inactive

    I’m voting with the majority here. We can’t have them be “too big to fail,” but that doesn’t mean stepping in to make them smaller. We simply need to quit guaranteeing them against failure. When the government starts stepping in to try to regulate things, because the government can easily be bought by organizations with big money, the beneficiaries are always the big organizations with the big money.

    • #14
    • August 22, 2012 at 7:41 am
  15. Profile photo of Percival Thatcher

    Andy Jackson, call your office.

    • #15
    • August 22, 2012 at 7:50 am
  16. Profile photo of Don Tillman Member

    Given the problems with institutions that are too big to fail, and the problems having the government step in and break them up…

    Why not just have a tax policy that provides a disincentive for banks to grow so large?

    • #16
    • August 22, 2012 at 8:06 am
  17. Profile photo of David Foster Member

    Mel Foil…”Big banks are probably needed for big mergers and acquisitions.” Why?

    Let’s say I’m Honeywell and I want to merge with United Technologies. Agreeing on the terms of the deal does not *inherently* require the involvement of any investment bankers; that is merely a convention that has arisen. I’ll need lawyers, for sure, to wrestle with antitrust issue and write/review language on the merger agreement, but I don’t *really* have to have bankers.

    To *execute* the merger, I need to send cash and stock to the former shareholders of UTX. This is a purely mechanical operation, involving a great amount of paperwork/electronic logistics, but not inherently requiring any particular level of assets on the part of the services that perform it.

    • #17
    • August 22, 2012 at 8:07 am
  18. Profile photo of mask Inactive

    I’m for letting banks fail and cutting back on all sorts of legislation which favors big banks over smaller banks. The regulatory scheme should not favor anyone and the market should be allowed to work.

    One could argue that the banks have gotten so big (and have gained such an advantage from government collusion) that the market can no longer function well. It’s possible but I’m not convinced – what are the chances that the “fix” and the “break up” would favor some political clients (banks) over others? We saw how the GM “bankruptcy” went down – non-union clients getting axed and the unions getting special favors. Why should we expect anything different with breaking up banks (which are much more complicated than an auto company)?

    • #18
    • August 22, 2012 at 8:18 am
  19. Profile photo of KarlUB Inactive

    We have a chicken/egg problem. We all agree that no large banking institution should be protected by the government. But as it stands right now they are protected by the government because they are so large.

    Thus the only way to rip away the government protection– and thereby snatch away a huge amount of power from the Feds– is to break up the big banks.

    One would think the public appetite for such a move is high right now. Is it high enough to overcome the power of bank lobbying and the lust for Congress to meddle with that market and thus aggrandize power to itself? Probably not. But I would like to find out.

    The simple act of proposing such legislation, at least, would flush out the rats in the ship.

    • #19
    • August 22, 2012 at 8:20 am
  20. Profile photo of donald todd Inactive

    I believe that there were different banks serving different purposes. There are commercial banks that handled mergers, and there were community banks (or savings and loans, or credit unions) which handled small businesses and individual depositors.

    Perhaps the merging of those functions and the blurring of those lines was not good.

    Perhaps making the government responsible for the fact that the banks cannot fail was a very bad thing. Officers and boards of banks that can fail will act differently than their cannot fail peers.

    However that means that demands such as the Community Redevelopment Act, which forced banks to approve loans to people who could not pay them back, are also inappropriate.

    • #20
    • August 22, 2012 at 8:22 am
  21. Profile photo of Trumpus Maximus Meridius Decimus Abacus Member

    Calling Nicole Gelinas:

    Canada did not fall into the trap of the Glass-Steagall Act which unwisely believed that making banks smaller and difficult to expand across state lines would ensure financial viability. Geographic diversification of mortgage portfolios for example allows a big Canadian bank to survive a mortgage meltdown in Ontario, because it has holdings elsewhere in Canada.

    I’m not claiming the Canadian model is perfect nor that we don’t have our own problems, but I think the US model of “community” banking suffers from a fundamental engineering problem. I leave it to those who write on the banking industry to discuss on a Ricochet podcast, but “busting up the banks” begs the question:

    Into what? More and smaller community banks isn’t a viable solution.

    • #21
    • August 22, 2012 at 8:49 am
  22. Profile photo of Roberto Member

    Perhaps in considering this question it would be beneficial to review some of the activities the largest financial firms have been engaged in recently:

    MF Global

    A criminal investigation into the collapse of the brokerage firm MF Global and the disappearance of about $1 billion in customer money is now heading into its final stage without charges expected against any top executives.

    HSBC Holdings

    HSBC Holdings, accused in a Senate report this week of exposing the U.S. financial system to illegal funds from Saudi Arabian terrorists, Mexican drug cartels and rogue regimes in North Korea and Cuba, will send a lineup of executives Tuesday to face a Senate subcommittee and apologize.

    Deutsche Bank, Barclays, Lloyds Banking Group, etc. 

    “The Libor manipulation is presumably the biggest financial scandal ever,” says Majcen, … Yes, he says, it did shock him that something like this was even possible, namely that a group of international banks had been manipulating interest rates for years.

    Goldman Sachs Group Inc

    The report concluded that even as securities firms flooded the market with securitized mortgages and advised clients to buy them, firms privately used words like “crap” and “flying pig” to describe the financial instruments.

    Zero Prosecutions

    • #22
    • August 22, 2012 at 9:01 am
  23. Profile photo of Franciscus Inactive

    I beleive this is a web that has been woven for 99 years, since the establishment of the Federal Reserve system. Without a serious discussion about changing this system, which establishes the link between government and the central bank, everything else is superficial. Too big to fail started in 1913 on Jekyle Island.

    • #23
    • August 22, 2012 at 9:12 am
  24. Profile photo of Guruforhire Member

    I am a unicorn. I support TARP on moral grounds if the government takes overt acts to induce risks, which it did, than it has a moral obligation to make its portion of the disaster right. If you dont wanna pay when ot goes bad, dont induce regulations that cause problems. TARP is a symptom.

    • #24
    • August 22, 2012 at 9:28 am
  25. Profile photo of genferei Member

    I’m very wary of arguments either of the form “we can’t trust our politicians not to intervene in the future, so we need intervention now” or “here is a problem caused by regulation; let’s use more regulation to fix it”.

    • #25
    • August 22, 2012 at 9:33 am
  26. Profile photo of KarlUB Inactive
    Guruforhire: I am a unicorn. I support TARP on moral grounds if the government takes overt acts to induce risks, which it did, than it has a moral obligation to make its portion of the disaster right. If you dont wanna pay when ot goes bad, dont induce regulations that cause problems. TARP is a symptom. · 2 minutes ago

    Can’t say as I agree, entirely, but I see the point.

    Which makes it another argument to bust up the big banks and allow the new ones to fail. And Guru’s point would remain for small businesses and individual depositors via FDIC insurance.

    The rest? Well, gents, that is the business you have chosen. Deal with the prospect for failure, whether government has something to do with it, or not.

    • #26
    • August 22, 2012 at 9:36 am
  27. Profile photo of Doug Kimball Member

    I’ll try to get to the real point here. Banking used to be easy to regulate. Since savings rates were set, cost of capital was predictible. Loan at a good spread and keep expenses below your yield (lending rate less cost of capital) and make money. Fees were gravy; bad loans, the anathema. Regulators focussed on lending risk. Today, with fees paramount, banks are less predictible and more competitive. Spreads are insufficient to maintain a bank. Lending is still a risk, but competitive factors are more important. Fee based investment banking has exponentially increased bank risk and regulatory complexity. In the end, however, the Fed is on the hook for deposits, so bank health is paramount. Hence it is easier to pump cheap money and provide a flow of fees (SBA lending, mortgae placement and mortgage servicing) to keep banks solvent than it is to monitor elusive risks. And fewer banks means fewer entities to watch. But the risk, complex and concentrated as it is, is enormous. Going back to a more regimented, regional model, makes sense to simplify the model and spread risk, as does rebuilding the inpenetrable investment banking wall. Let investment bankers risk their own capital.

    • #27
    • August 22, 2012 at 9:57 am
  28. Profile photo of Freeven Member

    I claim no expertise on the subject, but this much seems clear to me:

    1) There is an unholy alliance between large banks and the government.

    2) Because those banks have so much power, any attempt to “break up the banks” will fail, as the same people who are corrupting the system now will be the ones engineering the “solution” and rigging the process to their benefit.

    3) Therefore, the problem of breaking the unholy alliance is best approached from the other direction: leave the banks alone and “break up” the government. The less power (especially over the economy) the government has, the less incentive and opportunity the banks (and other industries, for that matter) will have to buy government favors and corrupt the system.

    I believe it was Thomas Sowell who said that putting economic and political control in the hands of the same people is a recipee for disaster. That’s what we’ve done, and that’s what we’ve got.

    • #28
    • August 22, 2012 at 10:16 am
  29. Profile photo of Bereket Kelile Member

    I think Prof. Rahe is on to the right idea. There’s a tradeoff between big and small banks. When you have one small bank that services a local area there’s a lot at stake if that bank goes under. A larger bank with more assets is much more efficient and can diversify the risk. 

    The challenge of banking regulation is what’s called financial innovation. Whenever new regulations are created people come up with ways around it. All of this debate about too much/little regulation is a bit pointless since the financial instruments that were at the heart of this crisis were new. And of course there is the monteary policy factor that contributed to the crisis but I don’t want to digress too much. 

    • #29
    • August 22, 2012 at 10:36 am
  30. Profile photo of genferei Member
    Freeven: Therefore, the problem of breaking the unholy alliance is best approached from the other direction: leave the banks alone and “break up” the government. · 0 minutes ago

    So simple. And so true!

    • #30
    • August 22, 2012 at 10:42 am
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