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?

  1. 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.

  2. ConservativeWanderer
    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.

  3. Last Outpost on the Right

    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.

  4. BrentB67

    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.

  5. Keith

    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.

  6. Barkha Herman

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

  7. FloppyDisk90

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

  8. BrentB67

    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.

  9. Mel Foil

    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.

  10. Sumomitch

    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.

  11. flownover

    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.

  12. 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?

  13. Keith Preston

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

  14. Lucy Pevensie

    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.

  15. Percival

    Andy Jackson, call your office.

  16. Don Tillman

    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?

  17. david foster

    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.

  18. mask

    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)?

  19. KarlUB

    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.

  20. donald todd

    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.  

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