By Simon Johnson
An interesting debate is developing within the Republican Party on how to approach the problem of too-big-to-fail financial institutions.
On the one hand, a growing number of influential voices are pushing for measures that would limit the size of megabanks or even push them to become smaller. Richard Fisher, president of the Federal Reserve Bank of Dallas, continues to draw a lot of attention, as does Thomas Hoenig, the former president of the Federal Reserve Bank of Kansas City and now vice chairman of the Federal Deposit Insurance Corporation. And Jon Huntsman planted a strong conservative flag on this issue during his run for the presidency in 2011.
This assessment is now shared much more broadly across the right, as seen in recent opinion pieces by George Will and Peggy Noonan, as well as regular analysis by James Pethokoukis of the American Enterprise Institute, including on the issue I write about today. See this Holiday 2012 survey, provided by the Dallas Fed, with links to views in favor of and against breaking up the big banks.
Senator David Vitter of Louisiana and Jim DeMint, the former senator from South Carolina who now heads the Heritage Foundation, have also come out hard against very big banks. Both men are usually considered to be in the right wing of the party.
But some other Republicans are pushing back, as seen this week in a paper by Hamilton Place Strategies, a group headed in part by communications professionals who previously worked with President George W. Bush, John McCain and Mitt Romney. (The people involved insist that it is not a Republican firm. Of its five partners, four previously had senior Republican jobs, while the fifth worked for Hillary Clinton and other Democrats. Of its three managing directors, two have worked for Democrats and one was a senior staff member on the Romney campaign. Historically, of course, deference to big banks is bipartisan.)
Can Hamilton Place Strategies help turn the tide within Republican thinking? This is not likely, because its paper is not credible and should not be taken seriously for three reasons.
First, it fails to deal with the most important recent work showing the problems with big banks. For example, it essentially ignores the analysis of Andrew Haldane and his colleagues at the Bank of England, which finds no economies of scale and scope for the world’s largest financial institutions (the paper mentions the finding that economies of scale do not exist above about $100 billion but does not go into the specifics of this result). I see no mention of Richard Fisher and Harvey Rosenblum of the Dallas Fed, who explain clearly how megabanks weaken the effectiveness of monetary policy and undermine United States influence over all aspects of our financial system (a direct counter to one main point of the Hamilton Place Strategies paper).
The paper makes vague assertions about bank equity capital now being sufficient to withstand future adverse shocks, but it fails to take on any of the many concerns raised by Anat Admati and her co-authors, which are increasingly gaining traction. Professor Admati and Martin Hellwig have a new book, “The Bankers’ New Clothes,” which will be introduced on Monday at the Peterson Institute for International Economics (where I am a senior fellow); excerpts have been posted on Bloomberg. Anyone who wants to be taken seriously in this debate needs to read the book (and the technical papers already available).
Second, Hamilton Place Strategies denies the existence of too-big-to-fail subsidies for global megabanks. This is laughable. Has it talked to anyone in credit markets about how they price various kinds of risk – and assess the willingness and ability of the government and the Fed to support troubled megabanks? Or have its authors read the report on the SAFE Banking Act, produced by the staff of Senator Sherrod Brown, Democrat of Ohio? The International Monetary Fund, the Bank of England and other sources cited there put the funding advantage of too-big-to-fail banks at 50 to 80 basis points (0.5 to 0.8 of a percentage point, which is a lot in today’s market).
Such subsidies encourage big banks to borrow more – to take more risk and to become even larger. The damage when such a bank fails is generally proportional to its size. So this implicit taxpayer subsidy creates serious risks for the macroeconomy and contributes to the further build-up of taxpayer liabilities – when any financial system crashes, that causes a recession, reduces tax revenue, and pushes up government debt.
Even William Dudley, the former Goldman Sachs executive who now heads the Federal Reserve Bank of New York, acknowledges that too-big-to-fail and its associated subsidies continue. Daniel Tarullo, the lead Fed governor for financial regulation, is in the same place. (Again, neither is cited in the Hamilton Place Strategies document.)
Hamilton Place Strategies contends that large banks can be resolved – taken through liquidation by the F.D.I.C. without difficulties – and that the “living wills” process helps to provide a meaningful road map. I talk to people closely involved with these issues, officials and private-sector participants (as a member of the F.D.I.C.’s Systemic Resolution Advisory Committee and as a member of the Systemic Risk Council, led by Sheila Bair, the former chairwoman of the F.D.I.C.). Hamilton Place Strategies is completely wrong on the substance here.
Hamilton Place Strategies also asserts that global megabanks are an essential part of a well-functioning international economy. Again, I don’t know where this comes from. As part of my work at the Massachusetts Institute of Technology and at the Peterson Institute, I talk with people who run companies, large and small, operating around the world; they emphasize that they need financial services provided by well-run institutions and markets that have integrity.
Putting too-big-to-jail banks in charge of financial flows helps no one – except, presumably, the executives at those banks that the Department of Justice has determined are immune from criminal prosecution.
Third, the Hamilton Place Strategies “report” reads as if it is either some form of paid advertising or a sales pitch to potential clients — but the firm refuses to disclose for whom it is working and on what basis.
In response to an e-mail request for such information, Patrick Sims of Hamilton Place Strategies replied:
“While we don’t publicly disclose our individual clients, we make no secret that we do work for large financial institutions, both foreign and domestic, and related associations. It would be fair for you to note that in your writing. But the views expressed in the paper represent the longstanding views of the firm.”
I’m not sure what “longstanding” means, as the firm was founded in 2010. But in any case, this lack of disclosure completely destroys the credibility of Hamilton Place Strategies and its work in this area.
The firm is in the business of influencing opinion. As it says prominently on its Web site, “We show clients how to shape opinion, navigate challenges, make informed decisions and create opportunities.”
While the firm’s clients in this area may not be clear, the language in its report strongly resembles arguments being made by the Financial Services Forum and other lobbying groups for large banks. For example, an unsigned blog post on the Financial Services Forum’s Web site from November 2011 has the same arguments and similar wording to what is in the Hamilton Place Strategies report. (It also objects to an earlier commentary I wrote.)
Perhaps all this is a coincidence; the firm has not yet been willing to discuss these points.
When I acquainted the firm with what I was writing in this post and sought comment, the only substantive reaction was a request not to characterize it as a Republican firm.
We have seen deceptive lobbying, posing as objective “research,” many times in the financial reform debate – for example, the case of Keybridge Research on derivatives, which I wrote about in 2011.
If a company’s lawyer is quoted in the press, the report will always include mention of the client-lawyer relationship. Everyone is entitled to a spokesperson.
Law firms are not afraid to tell you whom they represent. After Charles Ferguson’s Oscar-winning movie, “Inside Job,” many academics now disclose when they produce a paper on behalf of an industry association (e.g., Darrell Duffie of Stanford disclosed that he was paid $50,000 by the Securities Industry and Financial Markets Association, a lobbying group, to write a paper opposing the Volcker Rule). Karen Shaw Petrou, a leading banking analyst with whom I have also disagreed on too-big-to-fail issues, discloses “selected clients and subscribers” in some detail.
Upton Sinclair once quipped, “It is difficult to get a man to understand something, when his salary depends upon his not understanding it.”
Hamilton Place Strategies’ decision not to disclose who is paying for its “research” is far more significant than all the errors in its white paper.
An edited version of this post appeared this morning on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire column, please contact the New York Times.