“Legitimate concern about the risks to taxpayers and the economy posed by banks that are “too-big-to-fail” has prompted some observers, among them Simon Johnson, former chief economist of the International Monetary Fund, to favor draconian limits on financial institution size. This is misguided. There are sizable gains from retaining large, complex, global financial institutions—and other ways to credibly protect taxpayers from the cost of government bailouts.”
And the article goes on to make the detailed case for keeping intact our largest banks – in contrast to the recently expressed views of two former Federal Reserve chairs (Paul Volcker, Alan Greenspan) and – late Tuesday – the current governor of the Bank of England (Mervyn King), who are calling for these banks to be broken up in some fashion.
Professor Calomiris, to his credit, emphasizes (in his second paragraph) that we cannot currently deal with the failure of large cross-border financial institutions and this huge hole in our regulatory structures has helped and will help large banks to press for bailouts. But he also insists “the challenge of coordinating the efforts [when a bank fails] among different countries’ regulators can be met through prearranged, loss-sharing arrangements that assign assets to particular subsidiaries based on clear rules. This would make it possible to transfer control over the assets and operations of a large international financial institution in an orderly fashion, in case of its failure.”
Theoretically, he may be right. But how far are we from being able to implement such a process?
The G20 should have taken this on as an essential priority at Pittsburgh, but it did not. The IMF has for years pushed the European Union or at least the eurozone to adopt the kind of framework that Calomiris advocates, but to little avail.
Perhaps this is due to bureaucratic inertia. More likely it is, once again, the blocking power of big banks.
In any case, once this hurdle is overcome, we can talk in more detail about the Calomiris arguments that big firms need big banks (odd, because big firms can go directly to securities markets), that the latest banking mergers created great value (possible, just not generally what most research finds), and that the rise of banking-as-derivatives-trading over the past 30 years has had big positive effects on the rest of the economy (strange, as there is no supporting evidence in the literature).
Competition between banks is good – on this Calomiris and I agree. We differ with regard to whether allowing large quasi-monopoly banks to dominate the landscape (e.g., Goldman Sachs and JP Morgan Chase today) is helpful to competition in any sense.
We should also throw into the mix three additional considerations.
First, the expected costs of allowing “too big to fail” banks to continue to operate are huge. The Calomiris benefits might be positive, you need to weigh these against what we have just seen: a huge recession (and the risk of worse), a big increase in government debt (perhaps 40% of GDP, when all is said and done), and almost 6 million jobs lost. Calomiris wants to assume these away, with an “immaculate regulation”, but this is simply implausible.
Second, the big banks definitely create some private benefits – mostly for the insiders, in the form of upside (e.g., bonuses) when times are good. The costs are born by society and not just by people who lose their homes – it’s businesses all across America that have lost income, fired people, and are now struggling to stay afloat. This is not only unfair, it is inefficient. Excessive risk taking by big banks generates massive negative externalities. You can either price this appropriately (and good luck with imposing that tax) or break up the banks – down to a size where we know the FDIC can handle bank failures (see the latest failed bank list).
Third, our big banks have demonstrated an unmatched ability to take over regulators and to convince politicians that a dangerous financial structure is good for America. These same people will almost certainly render ineffective whatever new regulations you put in place. More broadly, how can you run a well-functioning political system when a few large banks are so powerful?
The key insight at the heart of breaking up Standard Oil in 1911 was that it was too big to regulate. That breakup may have been good for competition; it was certainly good for democracy.
As Nicolas Trist – secretary to President Andrew Jackson – said about the incredibly powerful privately owned Second Bank of the United States, “Independently of its misdeeds, the mere power, — the bare existence of such a power, — is a thing irreconcilable with the nature and spirit of our institutions.” (Schlesinger, The Age of Jackson, p.102)
By Simon Johnson
A slightly edited version previously appeared on the NYT’s Economix; it is used here with permission. Please ask the New York Times if you would like to republish the entire post.