By James Kwak
We’ve cited Thomas Hoenig, president of the Kansas City Fed, a number of times on this blog for his calls to be tougher on rescued banks and to break up banks that are too big to fail. This has been a bit unfair to Richard Fisher, president of the Dallas Fed, who has been equally outspoken on the TBTF issue (although we do cite him a couple of times in our book).
Bloomberg reports that Fisher recently called for an international agreement to break up banks that are too big to fail. Here are some quotations, taken from the Bloomberg article (the full speech is here):
“The disagreeable but sound thing to do” for firms regarded as “too big to fail” would be to “dismantle them over time into institutions that can be prudently managed and regulated across borders.”
“Given the danger these institutions pose to spreading debilitating viruses throughout the financial world, my preference is for a more prophylactic approach: an international accord to break up these institutions into ones of more manageable size. If we have to do this unilaterally, we should.”
“The existing rules and oversight are not up to the acute regulatory challenge imposed by the biggest banks. Because of their deep and wide connections to other banks and financial institutions, a few really big banks can send tidal waves of troubles through the financial system if they falter.”
This is not the first time that Fisher has sounded this alarm. Last fall, he called too-big-to-fail banks a “the blob that ate monetary policy,” arguing that they distorted the economy in ways that made it harder for the Fed to fight the economic downturn. This was the core of his conclusion:
“To craft a smart solution to this vexing problem of banks considered too big to fail requires that we deal with the way people and businesses really are. To me this means finding ways not to live with ’em and getting on with developing the least disruptive way to have them divest those parts of the ‘franchise,’ such as proprietary trading, that place the deposit and lending function at risk and otherwise present conflicts of interest.”
The TBTF debate is mainly between people like Fisher and Hoenig (and Paul Volcker and Mervyn King) who think that the problems posed by megabanks (implicit government guarantee, competitive distortion, etc.) cannot be regulated away, and people like Ben Bernanke and Tim Geithner who think that they can. (There are also a few people in free market fantasy land who think that the government can simply promise never to bail out another bank and that market forces will take care of the rest.)
Seen in an abstract light, we can have no assurance that any new regulations will actually work to prevent a financial crisis or defuse one, so the safer option (and isn’t that what regulators should want?) is to break up the big banks. Most of the arguments against this course of action have something to do with international competitiveness (smaller U.S. banks would hurt American companies in the globalized world). I think those arguments are obviously flawed; globalization means that American companies can get their financial services from banks that happen to be headquartered anywhere in the world, not just U.S. banks. But even if we grant them for the sake of argument, the international agreement that Fisher suggests should take care of that issue. And the only way to get such an international agreement is for the U.S. to take the lead.
Politically, breaking up TBTF banks is something that should on paper be able to attract a bipartisan majority. Many progressives are in favor of cutting “Wall Street” down to size; so are some conservatives, on the grounds that TBTF banks enjoy an implicit government subsidy and would require a bailout in the event of a crisis. Thomas Hoenig is generally considered a relatively conservative Fed bank president, at least when it comes to monetary policy. (Of course, such a bipartisan majority would require some Republicans to vote for something that might be popular with the electorate, which might be impossible in the current political climate.)
For whatever reason, the administration and Christopher Dodd seem to be going for the other kind of majority — one that cobbles together a least-common-denominator reform package that leaves the basic financial system intact. Even if they succeed, at best we will have lost our best opportunity for real change in decades.
The Baseline Scenario 
Does he mention TBTF insurance companies — including AIG?
Breaking up just banks might not solve the problem.
Oh how I wish we’d reconsider the usefulness and application of our antitrust laws.
“we will have lost our best opportunity for real change in decades”
The Importance of Distinguishing Between Features and Bugs.
The last paragraph is somewhat surprising. Are you willfully refusing to acknowledge that avoiding real change in the financial industry has emerged as the primary goal of the administration and congressional leaders? And are you doing it to build tension for dramatic effect, or what?
I think you might be underselling the lack of support that the breaking up banks idea has in non Anglo-American systems. It seems like there are some places where there are banks with dominant market shares that have been effectively regulated, I’m thinking in particular about Canada and Spain where it seems like there are a couple banks that are TBTF in those economies. I haven’t heard that the break up the banks meme has really caught on in continental Europe in general and I think there are some cogent arguments there. Now I also think that the political economy of the US would prevent effective regulation of the kind that Spain and Canada can enforce and American TBTF banks are on a different order of magnitude in size than those banks but it should still be explored.
…people like Ben Bernanke and Tim Geithner who think that they can. (There are also a few people in free market fantasy land who think that the government can simply promise never to bail out another bank and that market forces will take care of the rest.)
I think it’s likely Bernanke and Geithner (and Obama) don’t care whether the “problems” can be regulated away or not, because they don’t see them as problems.
These persons are ideologically committed to delivering the highest bank profits possible. They sincerely believe that to be the purpose of society, which they see as a kind of resource mine for the big banks, and big corporations in general. That’s what neoliberal ideology is. (The Republicans, I imagine, are more likely to be self-aware crooks. Why one becomes a Democrat rather than a Republican nowadays seems often to be a matter of honesty with oneself.)
So while they may prefer a “business cycle” without crashes (although any objection to disaster capitalism would be out of prissiness, not morality), they don’t regard preventing crashes and subsequent bailouts as being sufficient reason to impose any action which would compromise concentration and profits. So while they may convince themselves that e.g. breaking up TBTF rackets is not necessary to prevent crashes, in the end they don’t care one way or the other, since the real reason to oppose such a measure is because these cadres are dedicated directly to the further concentration of these rackets.
Don’t forget the other drum that Mr. Fisher is beating:
http://www.dallasfed.org/news/speeches/fisher/2010/fs100210.cfm
“According to our calculations at the Dallas Fed, that unfunded debt of Social Security and Medicare combined has now reached $104 trillion—trillion with a ‘T’—in discounted present value.”
“…they distorted the economy in ways that made it harder for the Fed to fight the economic downturn.”
Gary Gorton discusses (http://online.wsj.com/public/resources/documents/crisisqa0210.pdf) how Repo contracts essentially have become a form of money. This money supply is fairly independent of the Fed. Thus, the Fed’s ability to steer the economy is constrained because the money supply of the economy is not under the Fed’s control.
In the case of the Repo market, it wasn’t fiat currency (at least, not exactly). It was an asset standard (similar to a gold standard). The assets used were primarily mortgage securities. When their (perceived) value dropped, the money supply contracted disastrously.
That is my reading of Gorton. To him TBTF banks are not per se a cause of the crisis (but he says nothing about the ongoing recession). In this light, TBTF banks are just the thing standing in between the Fed and the money supply (the Repo market).
“The TBTF debate is mainly between people like Fisher and Hoenig (and Paul Volcker and Mervyn King) who think that the problems posed by megabanks (implicit government guarantee, competitive distortion, etc.) cannot be regulated away, and people like Ben Bernanke and Tim Geithner who think that they can.”
Does it matter which of these is true? Perhaps we could both eliminate TBTF banks via antitrust law application and regulate remaining banks as we regulate water, electricity, gas, etc. utilities.
Perhaps we need to look at TBTF in media first, before we can even find out what’s going on in the banking sector.
nice blog.
the FED itself is what needs to be broken up !
who owns the Federal Reserve and why don’t you know?
http://earthblognews.wordpress.com/2010/02/25/who-owns-the-federal-reserve-and-why-dont-you-know/
regarding media, I think you mean TBTRA — Too Big To Report Accurately
submit your own acronyms below this line.
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You know I think its hilarious that the Fed didn’t want to regulate any financial institutions, but two of its governors are calling for a break-up of TBTF banks. Can’t the governors collectively vote to override the chair and just start doing this since they have a national fiduciary duty?
Seems like the principals that apply to networks, apply to our banking “network” The most resilient design is a decentralized one, with many nodes handling about the same amount of traffic (the internet). Designs with large “hub” nodes while potentially more efficient using resources, are less reliable and robust, especially exposed when one of the “hubs” fail. They also spread “virus’s” much more readily.
Adaptive systems always crash. It’s a property of adaptive systems. This is actually theoretically very well known problem of adaptive systems.
Outspoken? We’re done with outspoken. Time for a fundamental teardown/rebuild.
We still have that little problem of vetting and/or educating a new group of administrators, stewards, watcher-watchers, whatever you want to call them.
I can see where in the hypothetical that regulation could solve the TBTF problem, and may be did so in Canada.
However, US banks fight any regulation to the proverbial “tooth and nail”. Ultimately, this probably means that they will need to be both broken up and regulated more stringently than if they would behave otherwise in order to guarantee their, and the financial systems, safety and soundness.
As to when, well if it is not this bust, it will be the next big one, or the next until it is figured out. Sort of like, is this 1909, or the Great Depression learning experience?
DWN
I should have written TBTS: Too big to succeed.
“Most of the arguments against this course of action have something to do with international competitiveness…”
I’ve never entirely understood that. Let’s say that the US told Citigroup “we’re tired of you: get smaller or GTFO,” and they opted to move to the UK. So the next time they blow up — and there will be a next time — the Brits can bail them out instead of us.
Fine by me. Let ’em go.
James writes:
Just like health care.
Mission accomplished!
Yeah, I was thinking the same. This is exactly the result the lobbyists have paid for, and politicians have accomplished it with minimal interference.
Exactly. It reminds me of the arguments for massive salaries and bonuses to banks. “Well if we don’t have those then we can’t retain the top talent.” You know… the talent that caused all this destruction but made banks so very very rich. Now there’s an argument to keep these banks on our soil so its our job to wipe their butts when they crap themselves.
Somehow I have trouble seeing a negative if the banks lose their “talent”, and similarly I have trouble seeing the negative if we don’t have responsibility for cleaning up their screw ups anymore. (Granted, if anyone KNOWS a negative that outweighs the positive of not cleaning up these messes anymore, please enlighten me)
Of course, Mervyn, Paul, Thomas, and now Richard, are absolutely correct in their assessment of the situation. The fact that Dodd and the Administration are not heading in that (popular and populist) direction is just more proof of the power of the financial oligarchs, who have coopted all of their potential enemies who might be in positions to do them harm. The simple imposition of a new Glass-Steagall would, no doubt, go a long way to creating the inevitable reduction which we seek, in the size and power of the TBTF’s, but now that the Supremes have given their blessing to endless campaign spending, anything resembling serious financial reform is solidly and perminently in our rear view mirrors, at least until the next bubble bursting (which will happen, we all know, sooner or later).
Word!!!
If ya think about it, those sky high top talent salaries are deserved. That super elite group of CEOs got huge returns on super high risks and then got everybody else to suffer the consequences.
In a reluctant way I have to say “Well Done.”
I wonder how long till the next crisis?
Here is a point that I don’t hear many people discussing. These big banks are seen by many to be a part of the power structure of the countries that they seem to represent. If they are this, then breaking them up is to lessen the total (financial) power that a country can exert in the world. This could be seen as a large negative for any nation’s leader, who wants to preserve and grow his nation’s power.
If they are simply pirates as I see them, willing for profit to do things that might hurt any individual country, then it would behoove any and all national leaders to make sure their power is significantly diminished so that they will hurt no one. If one sees them as pirates, they are not controlled by any democratically elected body, not subservient to the best interests of the (any?) public. As pirates they are unequivocally amoral and cannot be trusted any more than a sociopath can be trusted.
As Spock would say, “They must be broken up for the good of the many.”