Small Bank Big Trouble?

One of the more interesting counter-arguments against the idea that big banks should be broken up comes from people who play close attention to the behavior of small banks.  They point out that small banks are a powerful political lobby, a point nicely illustrated by the NYT’s explanation of how changes to bankruptcy law were recently derailed.

The big banks, in this view, are no more oligarchic in their tendencies than small banks.

It is definitely the case that small banks can get together and demand political favors.  You need transparency and a strong open debate to offset that – and, according to leading congressional figures, you also need the Obama administration to show up, help out, and resist capture:

“Moreover, Timothy F. Geithner, the Treasury secretary, did not seem to share Mr. Obama’s enthusiasm for the bankruptcy change.

Mr. Geithner was lobbied by the industry early. Two days after he was sworn in, he invited Mr. Fine from the community bankers to his office for a private meeting. The association, with influential members in every Congressional district, is one of Washington’s most powerful trade groups.”

The more interesting question is whether many small banks could copy each other’s behavior and create a situation where they are all “too big to fail” at more or less the same moment.  Some call this lemming behavior, but that may be unfair on the little critters.

Surely this is very hard to pull off in practice.  In his Logic of Collective Action, published in 1965, Mancur Olson argued that it’s hard for large groups to cooperate effectively, particularly when there’s an incentive to “free ride”.

What would free riding mean in this context, which is somewhat different from the public goods provision issue that Olson focused on?  Probably it would mean pretending that you’re just like the rest of the pack, but quietly hanging back as the pack heads towards the next subprime-type cliff – and then buying up everything you want from the wreckage.

Then you get to run ads like JP Morgan currently has over at the Atlantic – in a nice, but surely coincidental irony, this currently shows above the top of The Quiet Coup.  And, less likely to coincidental, the JP Morgan campaign has almost the same name as the main “constrain the big banks” movement: A New Way Forward.  (Presumably, Jamie Dimon, head of JP Morgan, couldn’t persuade McDonalds to part with the relevant rights to I’m Lovin’ It.)

The failure of big banks endangers financial systems and their rescue – as organized by the Bush and Obama administrations – results in a massive increase in the public debt.  The failure of small banks is an issue in some countries, but in the U.S., the FDIC takes them over for breakfast – here’s how they spent Friday.

Lemmings of the world, watch out for Jamie Dimon.

By Simon Johnson

17 responses to “Small Bank Big Trouble?

  1. “What would free riding mean in this context, which is somewhat different from the public goods provision issue that Olson focused on? Probably it would mean pretending that you’re just like the rest of the pack, but quietly hanging back as the pack heads towards the next subprime-type cliff – and then buying up everything you want from the wreckage.”

    Ah, but if you are constrained in size, is this really on optimal strategy. Just when you’d want to take advantage of others’ mistakes, you’d find that the government won’t let you. Meantime, if you follow the herd, the government can’t pick on you since they’d have to pick on everyone

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  3. Speaking of banks — check out what Karl Denninger has to say about the current goings-on with UBS.

    ~ http://market-ticker.denninger.net/archives/1092-Banks-Honest-Surely-You-Jest!.html

    If UBS doesn’t want to play by the US rules, then perhaps they and their current US clients should be stripped of “living” in the US.

    As I noted to a couple of people last week: Everything that is going on economically – all the decisions and efforts – make perfect sense once you understand it is all about (i.e. for the benefit of) the banksters and their groupies.

  4. Many small banks, in fact, resisted the urge to run over the cliff. I can see how they might be resistant to stricter oversight or more debtor-friendly bankruptcy laws.

    I think this highlights the fact that good management could have averted much of the bank problems. There is a bank in my small, western town of Jackson Hole that, in the midst of an unholy real estate boom, refused to lend without money down or verified income. And all the speculators hated them. And there is another bank that lent to anyone with a pulse. They were visited by the FDIC last month.

    We shouldn’t overlook this point. And, conversely, we should not buy the argument that bankers just did what they had to do, because everyone else was doing it. You don’t have to dance just because the music is playing. Many banks did not.

    Poor management was a huge factor in this crisis. Note that poor management does not necessarily mean stupid management, although sometimes that was the case. But the idea that good management would not have made a difference should be dismissed.

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  6. In all your bank raves in print and on tv you
    omit the following one point. The economy is and will
    continue to shrink(not the L you predicted on tv) and therefore fewer
    banks are needed to loan and hold money. In San Diego

    a downtown bank needs to be converted into

    a food stamp center.

    The Feds action is TO maintain the

    same number of banks pre-depression.

  7. What have Bernanke & Geithner been doing for the last 4-5 years? Wasn’t their job to prevent financial crises from happening? Isn’t that what we’ve been paying them to do? We don’t need a couple of highly paid, brain dead pseudo-intellectuals to call down to the Mint & tell them to start printing more free money for their stupid friends in banking who lost billions of OPM by making stupid investments with it. My 5 year old grandson will gladly call the Mint for free & tell them to start the printing presses. The easiest job (position) in the world is spending OPM. That’s why politicians hit up their fat cat friends for millions in contributions (payoffs) to get reelected. So they can spend OPM.

    Of course Ben & Tim have to print all this free money for their friends in banking if they want to take advantage of the multimillion dollar banking/lobbying “positions” their friends in banking have waiting for them after they leave government.

  8. “Too Big to Fail” seems a twisted allusion ‘channeling’ the Titanic. Its pretty clever too because they’re imparting an imperative that resonates as a statement of fact. These four words akin to a paradox, ignore the hard reality that if something IS already failing or as some have argued HAS already failed, then surely its not too big to fail!

    The smaller banks should have an easy time, branding a large group of them as “Too Big to Fail”. The statement has no basis in reality and yet appears quite affective with some. Taken at face value, this is a forward looking phrase, that attempts to suggest that ‘failure’ can be avoided. I guess that’s how you get “zombie banks”. If we say that something isn’t dead until we certify it as dead regardless when it died, then in that world “Too Big to Fail” has legs. I’d guess their PR people came up with this. Its easy to remember and has poetic redundancy, what’s not to like. The logic behind it is a trojan horse however. If you ACCEPT that due to size and number of people and businesses affected by its demise is catastrophic in nature and AGREE that it must be dealt with in a different manner, then you’re just a sale or two away from a bundle of small banks saying hey, if you put enough of us together, you could be looking at the same cataclysm so give us the same ‘hook up’ you gave the big guy.

    Too bad regular citizens can’t get the same deal. Who would a large group of potentially millions of citizens go to and ask that their plight be given consideration because of their vast numbers and the affects of their collective demise on the whole of the country. Oh, that would be Congress. Hey, how can I become a bank!!!

  9. DesolationRow

    Honestly, I don’t believe that the small banks have a powerful lobbying group…as long as the FDIC can shut them down, they’re not THAT powerful. The most amazing thing here has been and continues to be the double-standard this administration (and the previous) has for small banks/individuals/car manufacturers vs large money center banks. Wait, actually maybe how obvious they’re making the double-standard might be the most amazing here. I can’t fathom why Obama can’t or doesn’t want to see this…is it because the big bank lobby is too powerful and he’s saving all his political capital for the health-care reform fight? If so, that’s too bad…he could have been on the $10 bill by now.

  10. So, what else is new? Small banks, big banks, banks will be banks, and many are learning just how far they can go. Geithner is pledged to the bail outs. What was very revealing was Tim’s testimony recently where he pointed out the the TARP is structured (I’m sure Treasury did this wording) as a revolving line of credit, so that when the repayment occurs, the TARP funds are renewed to the extent of the repayment. The cycle, therefore, will continue, as the small bank failures mount and the large ones need further capital infusions. Which will happen later this year. The Stress Tests were bogus, and the Treasury will continue to prop things up, ad infinitum. Interesting that the small bank lobby is so strong, but I believe that Geither’s predispositions engender more strength that there really is.

  11. Seems to me the issue lies with lobbying by any business, banks included. Time and again we see legislation that is the result not of the people petitioning their Congresspeople but of businesses virtually (in some cases actually) writing legislation for themselves and getting what they paid for. This is the heart of the huge problem within our democracy of which the financial hijinx is just a part.

  12. i don’t see any reason why a collection of small banks all doing more or less the same thing would be any safer than large banks doing more or less the same thing.

    i think that size is a red herring.

    another datapoint is that millions of households participated in the same bad bet the banks did. no one would suggest collusion in this case.

    a cycle of mass delusion which appears to be feeding you for a time is really tough to break.

  13. There is another possible reason that small banks might be better. While they may aggregate the same type of risk, they would be much easier for the FDIC to take over, from a logistical standpoint.

    And as powerful as the small bank lobby may be, they don’t seem to be very effective at preventing that kind of action.

  14. q: “i don’t see any reason why a collection of small banks all doing more or less the same thing would be any safer than large banks doing more or less the same thing.”

    There is greater spread with more banks.

    “i think that size is a red herring.”

    Size matters. “Too big to fail” banks, as we have seen, are treated differently from smaller banks. And that has been true for a long time. They count on it.

    A relatively small part of AIG brought it down. One trader, with poor oversight, brought down Barings some years ago. Size multiplies effects.

    “another datapoint is that millions of households participated in the same bad bet the banks did. no one would suggest collusion in this case.”

    You bet there was collusion. Mortgage brokers encouraged borrowers to fudge on their income statements, and assured them that when their rates went up, they could refinance. Who was not deluged with offers from credit card companies? It’s all part of the same picture. As for bets on derivatives, the big financial players did that. Any participation by householders was unknowing.

    “a cycle of mass delusion which appears to be feeding you for a time is really tough to break.”

    From what I hear, the Fed is reluctant to burst bubbles. How hard can it be?

  15. the FDIC does not generally ‘take over’ banks. the FDIC facilitates sales of banks to other (generally larger) banks. occasionally the FDIC liquidates a bank’s assets, but that is typically rare (though becoming more common now, and not the first choice). so if banks are size-limited, then we’ll need another plan.

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  17. last year, the federal government projected that over 2,000 banks would fail in 2009. while we aren’t even close to that number right now, the seizure of the oversight banks in the credit union industry is the same thing to all of those credit unions being seized by the government. it’s not that the barack obama people are being hard to deal with, it’s that there is an agenda to consolidate banking control nationally and globally.