By Simon Johnson, co-author of 13 Bankers
Bank size is suddenly the issue of the day – with politicians lining up to oppose any meaningful restriction on the size of our largest banks. Their reasoning is varied and all quite flawed, particularly when they insist there must be no Senate floor debate on the Brown-Kaufman amendment.
Senator Dick Durbin may be right to say that the Brown-Kaufman amendment is “a bridge too far” and will not pass in this legislative cycle – presumably this sounds like a tactical political assessment. Surely in that case he would not oppose bringing it to the floor of the Senate and allowing that body to prove him right (or wrong).
Senator Chris Dodd opposes the amendment, but his reasoning is rather vague. Here’s what he says in his interview with Ezra Klein, which appeared yesterday,
“It’s not size; we’re preoccupied with size. And I’m not suggesting that any size is okay, but it’s really risk, it’s these other elements in here. A relatively innocuous product line in a relatively small company can pose huge, systemic risk. That said, in our bill, we provide the authority to break up companies. That is clearly in the bill, the authorization to do that under certain circumstances. But I’m not sure that we ought to become so preoccupied with it. And again, I’ve looked at the 13 Bankers book, and so forth, that approach, and hear this, by the way, not just from them, but from CEOs of major corporations. This is not some left/right question. But I just don’t think that it makes a lot of sense. I don’t think it’ll prevail.”
Senator Dodd is completely correct that this is not a left/right question and he is also correct that come CEOs and other heavy hitters from the business sector completely agree with us.
But his other reasoning is shaky. No one disputes that risk is the issue here. But our proposal to reduce bank size is in addition to everything already in the bank bill – so in order for this to be a bad idea, you would need to argue that breaking up the big banks would actually lead to more system risk.
Given what we have learned about the serial incompetence of megabanks, with their distorted incentives and perverse belief systems, such an argument seems like quite a stretch. But it is a stretch that Larry Summers – ever the top level debater – understands that the anti-Brown-Kaufman view implies or even requires:
“Brown: The too big to fail issue, why not go further? Why not just limit the size of banks?
Summers: Jeff, that was the approach America took to banking before the depression. That was the approach America took to lending in the thrift sector, before we had the S&L crisis. Most observers who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies, and hurt the competitiveness of the United States. But that’s not the important issue, they believe that it would actually make us less stable. Because the individual banks would be less diversified, and therefore at greater risk of failing because they wouldn’t have profits in one area to turn to when a different area got in trouble. And most observers believe that dealing with the simultaneous failure of many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment.”
There are two substantive points here (ignoring the rhetorical distraction in the first two sentences).
1) “Most observers who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies, and hurt the competitiveness of the United States.”
2) “Because the individual banks would be less diversified, and therefore at greater risk of failing because they wouldn’t have profits in one area to turn to when a different area got in trouble. And most observers believe that dealing with the simultaneous failure of many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment.”
I’m not sure who the “most observers” are with regard to either point. I have heard the arguments before but, as we review in 13 Bankers (see the last chapter), neither of these is the mainstream fact-based view regarding big banks.
The idea that breaking up big banks this would “hurt our ability to serve large companies” is often claimed by Jamie Dimon and some other bankers. But it is contradicted and refuted by the CEOs whom Chris Dodd cites. If you find a CFO from a nonfinancial US company who would like to discuss this in more detail (preferably in public, but we also talk to many people off-the-record), send them along – so far, no bankers have accepted our challenge to come out and debate.
On the idea that individual banks are more risky, this is obviously disingenuous. As Summers knows very well, the “risk of failing” depends on the amount of capital that banks have. Large banks have long believed they need less capital because they are well-diversified, but the weaknesses in their thinking were painfully exposed in September 2008.
Again, if you know a top banker who is willing to discuss in public how their risk management systems – broadly and appropriately defined – failed in 2008, and how those flaws have been fixed, please ask them to speak out in detail and with specifics. I understand they may be reluctant to engage in an open debate, but how about at least producing a working paper that has some verifiable evidence in it?
Summers is right that small banks can fail – in fact, they fail all the time in the US and he likes the FDIC resolution mechanism so much that he is proposing this as a way to deal with all financial companies (even though it cannot, by definition, work for large cross-border banks because it is not a cross-border authority). We need a financial system in which firms of all kinds can fail – without this, you no longer have any kind of “market” economy.
So the heart of Summers’s claim is that (1) small banks would all fail simultaneously, and (2) this would be more costly to deal with than what we faced in September 2008. Claim (1) is implausible – nothing is that synchronized, including his main supporting episode (the S&L crisis). Claim (2) is also not supported by any evidence – again, the S&L crisis was much less costly than the September 2008 fiasco (and after the S&L episode many people went to jail and even more thrifts went out of business – what’s our score on this round?)
Can Summers really claim, with any credibility, that a set of troubled smaller banks would have got the incredibly generous package of support received by the 13 bankers and their ilk? Of course not, smaller bankers would have been fired, their board of directors would have been dismissed, and their creditors would have faced losses (as with all small bank failures).
And Summers – or others – cannot fall back on the 1930s to say “small banks are bad.” The world has changed fundamentally since that time because we have deposit insurance. The domino collapse of small banks was a result of retail runs.
As I travel round the country presenting 13 Bankers to audiences – including leading experts on these issues, as well as just deeply interested and informed individuals – “most observers” agree that breaking up big banks is an additional measure that would reinforce the Dodd bill and reduce system risk. We agree that breaking up the banks is not sufficient for financial stability – we merely insist that it is necessary, particularly in a political system that has been so completely captured by the biggest bankers.
If you or Larry Summers have any evidence to the contrary, please send it to me. Or just put in on the web in a way that people can assess and critique.
Why is this critical question for our country’s future being fixed up behind closed doors? Why not come out into the open and have a proper public discussion as befits a democratic country.
Even better, let the Brown-Kaufman bill come to the Senate floor for a debate and an up-or-down vote. What exactly are the opponents of this suggestion afraid of?