Note: I’ve updated this post at the end with another response to Jamie Dimon, this one by James Coffman. Coffman served in the enforcement division of the SEC for over twenty years, most recently as an assistant director of enforcement, and previously wrote a guest post for this blog.
In the Washington Post, Jamie Dimon asserts that we shouldn’t “try to impose artificial limits on the size of U.S. financial institutions.” Why not?
“Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole.”
I don’t know of any serious person who believes this to be true for banks above, say, $100 billion in assets. Charles Calomiris, who studies this stuff, couldn’t find anything stronger to back up the economies of scale claim than a study saying that bank total factor productivity grew by 0.4% per year between 1991 and 1997 — a study whose author thinks that the main factor behind increasing productivity was IT investments.
“Artificially limiting the size of an institution, regardless of the business implications, does not make sense.”
Uh … obviously it makes sense. We all know that having banks that are TBTF is bad. One solution is making them smaller. Big banks may (theoretically) have benefits that outweigh the benefits of shrinking them. But shrinking them makes perfect sense unless those benefits are proven.
“To understand the harm of artificially capping the size of financial institutions, consider that some of America’s largest companies, which employ millions of Americans, operate around the world. These global enterprises need financial-services partners in China, India, Brazil, South Africa and Russia: partners that can efficiently execute diverse and large-scale transactions; that offer the full range of products and services from loan underwriting and risk management to providing local lines of credit; that can process terabytes of financial data; that can provide financing in the billions.”
Does Jamie Dimon really believe this? Doesn’t he run a bank when he isn’t writing op-ed articles? The last time Johnson & Johnson issued debt, it used eleven underwriters. The time before that, it used thirteen. (I only chose J&J because it was the example picked by Scott Talbott, a financial industry lobbyist.) Now, do J&J’s dozens of subsidiaries around the world all get local lines of credit from the same bank? Does J&J really want to be dependent on a single source of credit? (Actually, if that single source has a government guarantee, it could do worse.) If that’s actually true, someone please let me know. But the idea that one of the world’s largest companies would need a one-stop shop for financial services is what defies basic business sense.
Now, I’m willing to concede that there is value to having a global investment bank; at the least, you want trading operations covering all the time zones. And I’m willing to concede that there is some minimum scale to having a sophisticated trading and derivatives operation. But I go back to the number $270 billion. That’s how big Goldman was in 1998, adjusted to today’s dollars. I still haven’t heard a good argument about why the nonfinancial world has changed in a way that requires investment banks that are larger than $270 billion. I also haven’t heard a good argument why a $270 billion investment bank needs to be attached to a $1.5 trillion domestic retail bank (think of Bank of America).
“Capping the size of American banks won’t eliminate the needs of big businesses; it will force them to turn to foreign banks that won’t face the same restrictions.”
On one level, so what? If big American companies want to do business with UBS — a bank that gets bailed out by Swiss taxpayers when necessary — that’s fine with me, and fine with those companies as well. More seriously, of course, that means that Switzerland should also break up its big banks.
“Global economic growth requires the services of big financial firms.”
Just because you keep saying the same thing over and over again doesn’t make it true.
By James Kwak
Update: And here’s the response by James Coffman.
To the editor:
Jamie Dimon’s opinion piece, “No more ‘too big to fail’,” bases its argument on a false dichotomy and glosses over, at best, the very real problem of interconnectedness.
First, the choice facing lawmakers is not an either/or choice between a resolution authority to wind down failing financial institutions and the imposition of artificial and arbitrary limits on the size of such institutions. While the establishment of a resolution authority is probably necessary, it is not a substitute for restructuring the financial system to prevent TBTF institutions in the future and to remove the threat they pose today. The best, most effective and only proven method for doing this is to separate commercial banking, which is supported by the government’s guarantee in the form of deposit insurance, from the investment banking function, which involves much greater risk resulting from trading, securitization, development and sale of exotic financial products, etc. If those functions are separated, as they were for nearly sixty years until the 1990’s, the market will help control size and risk.
To enhance the ability of market forces to affect size and risk, it is important that investment banks in the future be owned in large part by their employees. If the bankers have their own net worth at stake, they will control the risk the institution assumes. Self-interest is a strong disciplinarian. Investment banks should not be publicly owned. Many of the recent reckless practices can be traced back to the demise of investment banking partnerships. Instead of public shareholders, let them rely on the credit markets and their own equity to finance their activities.
In order for the credit markets to act as a restraining force, all financial institutions should be required to make detailed, uniform and understandable disclosure of their financial activities and balance sheets. Only when such information is available can markets measure risk before lending or investing. The market can discipline risk only when it can measure it.
Finally, Mr. Dimon’s statement that the problem of interconnectedness of finiancial institutions is best handled by a resolution authority would be funny if it weren’t so dangerous and disingenuous. How can a resolution authority cure the interconnectedness problems of a failed institution that has billions of dollars of unhedged and unbacked credit default swaps or other derivatives outstanding? Interconnectedness problems must be identified and addressed before an institution fails. They can best be identified and measured if the underlying transactions that give rise to interconnectedness are known and understood by markets and regulators before the institution fails. The best means for accomplishing this is by establishing transparent clearing mechanisms and disclosure regimes. The banking industry is currently spending millions of dollars on lobbyists in an attempt to weaken such measures.
Our lawmakers need to resolve to never again allow financial institutions to become too big to fail. With the proper market structures in place, the markets can do that more effectively than micro-regulation. If the markets fail at this task, as they have in the past, regulators will have enough accurate and timely information to resolve such problems without huge slugs of taxpayer money and before such problems pose a threat to the world economy.