By Simon Johnson
Just over 100 years ago, as the nineteenth century drew to a close, big business in America was synonymous with productivity, quality, and success. “Economies of scale” meant that big railroads and big oil companies could move cargo and supply energy cheaper than their smaller competitors and, consequently, became even larger.
But there also proved to be a dark side to size and in the first decade of the 20th century mainstream opinion turned sharply against big business for three reasons.
First, the economic advantages of bigness were not as great as claimed. In many cases big firms did well because they used unfair tactics to crush their competition. John D. Rockefeller became the poster child for these problems.
Second, even well-run businesses became immensely powerful politically as they grew. J.P. Morgan was without doubt the greatest financier of his day. But when he put together Northern Securities – a vast railroad monopoly – he became a menace to public welfare, and more generally his grip on corporations throughout the land was, by 1910, widely considered excessive.
Third, there was a blatant attempt to use the political power of big banks to shape the financial playing field in ways that would help them (and their close allies) and hurt the remainder of the private sector – including farmers, small business, and everyone else. Senator Nelson Aldrich’s push to create a central bank after 1907 – to be underwritten by the government but controlled by big banks – ultimately backfired. The Federal Reserve, while far from perfect, was created with far more public control and greater safeguards than Wall Street had in mind.
The fact that Nelson Aldrich’s daughter was married to John D. Rockefeller’s son was not lost on anyone.
A hundred years later, we have come full circle – as the mainstream consensus again weighs what to do with today’s overly powerful banks.
There are differences, of course. We no longer fear individuals – it’s the organizations they run that can make us or break us.
And, strangely, it is not the power of big finance to control everything that has us worried – other than in some movies. Rather it’s the ability of major banks to generate the conditions that make major international financial crises possible – with the incentive to take risks that, when things go well, result in huge upside for bankers and, when things go badly, massive downside for the rest of us.
Even the supporters of our existing financial structure – men like Hank Paulson (in On The Brink), Larry Summers (in his 2000 Ely Lecture), and Jamie Dimon – concede that big crises occur every 5 years or so. What hit us in 2008-09 was not a “once per century” event. Rather it was the latest – and scariest – in a series of regular global crises that goes back to at least the 1970s.
At the heart of this pattern of behavior is a perception of invincibility among the folks who run our biggest banks – and following our most recent crisis they act more assured than ever that the government will provide a backstop.
At the same time, everyone agrees that such “too big to fail” arrangements cannot continue. Even the Federal Reserve, which has fallen on hard and embarrassing times since it was captured by Big Finance during the 1990s, now has its leading officials give speeches to this effect.
We like to think we live in a more professional and technocratic age than a century ago, so the central pretense of current reform efforts is that we can design a “resolution authority” of some kind that would allow the government to take big banks into a form of bankruptcy or liquidation.
But this notion of a resolution authority that can handle massive banks is a complete unicorn – a mythical beast with magical powers that does not really exist. A US resolution authority does nothing to help handle the failure of international banks – there is no cross-border resolution authority, nor will there be one anytime soon. If a Citi or a JP Morgan or a Goldman were to fail, our government would be in exactly the same awkward position as it was in during September-October 2008.
Big banks cannot be reined in through some clever tweaking of the rules. The issue before us is intensely political – just as it was in the first decade of the twentieth century. There is again a confrontation between concentrated financial power and our democracy. One side will win and the other side will lose.
The banks start with a definite edge. The public relations machines of today’s bankers may be even more effective than those of Morgan and Rockefeller – although the campaign contributions and control of the Senate exercised by those titans was immense.
But it is still early days – the Senate legislation expected this week or next will achieve nothing, except make the stakes clearer and motivations more transparent. If the banks win this round, as seems likely, they will become even larger – and more dangerous. At current scale, our megabanks bring no social benefits and great social risks.
Just as a hundred years ago, the consensus on big banks has to change. In this instance, either we break them up or they will soon break us all.
An edited version of this post appeared this morning on the NYT’s Economix; it is used here with permission. If you would like to reproduce in full, please contact the New York Times.