Note to Jamie Dimon: Repeating Something Doesn’t Make It True

Note: I’ve updated this post at the end with another response to Jamie Dimon, this one by James Coffman. Coffman served in the enforcement division of the SEC for over twenty years, most recently as an assistant director of enforcement, and previously wrote a guest post for this blog.

In the Washington Post, Jamie Dimon asserts that we shouldn’t “try to impose artificial limits on the size of U.S. financial institutions.” Why not?

“Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole.”

I don’t know of any serious person who believes this to be true for banks above, say, $100 billion in assets. Charles Calomiris, who studies this stuff, couldn’t find anything stronger to back up the economies of scale claim than a study saying that bank total factor productivity grew by 0.4% per year between 1991 and 1997 — a study whose author thinks that the main factor behind increasing productivity was IT investments.

“Artificially limiting the size of an institution, regardless of the business implications, does not make sense.”

Uh … obviously it makes sense. We all know that having banks that are TBTF is bad. One solution is making them smaller. Big banks may (theoretically) have benefits that outweigh the benefits of shrinking them. But shrinking them makes perfect sense unless those benefits are proven.

“To understand the harm of artificially capping the size of financial institutions, consider that some of America’s largest companies, which employ millions of Americans, operate around the world. These global enterprises need financial-services partners in China, India, Brazil, South Africa and Russia: partners that can efficiently execute diverse and large-scale transactions; that offer the full range of products and services from loan underwriting and risk management to providing local lines of credit; that can process terabytes of financial data; that can provide financing in the billions.”

Does Jamie Dimon really believe this? Doesn’t he run a bank when he isn’t writing op-ed articles? The last time Johnson & Johnson issued debt, it used eleven underwriters. The time before that, it used thirteen. (I only chose J&J because it was the example picked by Scott Talbott, a financial industry lobbyist.) Now, do J&J’s dozens of subsidiaries around the world all get local lines of credit from the same bank? Does J&J really want to be dependent on a single source of credit? (Actually, if that single source has a government guarantee, it could do worse.) If that’s actually true, someone please let me know. But the idea that one of the world’s largest companies would need a one-stop shop for financial services is what defies basic business sense.

Now, I’m willing to concede that there is value to having a global investment bank; at the least, you want trading operations covering all the time zones. And I’m willing to concede that there is some minimum scale to having a sophisticated trading and derivatives operation. But I go back to the number $270 billion. That’s how big Goldman was in 1998, adjusted to today’s dollars. I still haven’t heard a good argument about why the nonfinancial world has changed in a way that requires investment banks that are larger than $270 billion. I also haven’t heard a good argument why a $270 billion investment bank needs to be attached to a $1.5 trillion domestic retail bank (think of Bank of America).

“Capping the size of American banks won’t eliminate the needs of big businesses; it will force them to turn to foreign banks that won’t face the same restrictions.”

On one level, so what? If big American companies want to do business with UBS — a bank that gets bailed out by Swiss taxpayers when necessary — that’s fine with me, and fine with those companies as well. More seriously, of course, that means that Switzerland should also break up its big banks.

“Global economic growth requires the services of big financial firms.”

Just because you keep saying the same thing over and over again doesn’t make it true.

By James Kwak

Update: And here’s the response by James Coffman.

To the editor:

Jamie Dimon’s opinion piece, “No more ‘too big to fail’,” bases its argument on a false dichotomy and glosses over, at best, the very real problem of interconnectedness.

First, the choice facing lawmakers is not an either/or choice between a resolution authority to wind down failing financial institutions and the imposition of artificial and arbitrary limits on the size of such institutions.  While the establishment of a resolution authority is probably necessary, it is not a substitute for restructuring the financial system to prevent TBTF institutions in the future and to remove the threat they pose today.  The best, most effective and only proven method for doing this is to separate commercial banking, which is supported by the government’s guarantee in the form of deposit insurance, from the investment banking function, which involves much greater risk resulting from trading, securitization, development and sale of exotic financial products, etc.  If those functions are separated, as they were for nearly sixty years until the 1990’s, the market will help control size and risk.

To enhance the ability of market forces to affect size and risk, it is important that investment banks in the future be owned in large part by their employees.  If the bankers have their own net worth at stake, they will control the risk the institution assumes.  Self-interest is a strong disciplinarian. Investment banks should not be publicly owned.  Many of the recent reckless practices can be traced back to the demise of investment banking partnerships. Instead of public shareholders, let them rely on the credit markets and their own equity to finance their activities.

In order for the credit markets to act as a restraining force, all financial institutions should be required to make detailed, uniform and understandable disclosure of their financial activities and balance sheets. Only when such information is available can markets measure risk before lending or investing.  The market can discipline risk only when it can measure it.

Finally, Mr. Dimon’s statement that the problem of interconnectedness of finiancial institutions is best handled by a resolution authority would be funny if it weren’t so dangerous and disingenuous.  How can a resolution authority cure the interconnectedness problems of a failed institution that has billions of dollars of unhedged and unbacked credit default swaps or other derivatives outstanding?  Interconnectedness problems must be identified and addressed before an institution fails.  They can best be identified and measured if the underlying transactions that give rise to interconnectedness are known and understood by markets and regulators before the institution fails.  The best means for accomplishing this is by establishing transparent clearing mechanisms and disclosure regimes.  The banking industry is currently spending millions of dollars on lobbyists in an attempt to weaken such measures.

Our lawmakers need to resolve to never again allow financial institutions to become too big to fail.  With the proper market structures in place, the markets can do that more effectively than micro-regulation.  If the markets fail at this task, as they have in the past, regulators will have enough accurate and timely information to resolve such problems without huge slugs of taxpayer money and before such problems pose a threat to the world economy.

35 thoughts on “Note to Jamie Dimon: Repeating Something Doesn’t Make It True

  1. On the bright side, all the recent jibber-jabber from Blankfein and Dimon suggests that they believe there is a non-zero chance that Congress will actually do something about TBTF.

    Either that, or they are spewing out bald-faced lies because they know they have won, and they just like the idea of giving conniptions to the sort of people who read this site.

  2. Commercial banks have been, integrated over time, money-losing businesses. Nassim Nicholas Talib (The Black Swan) cites the fact that between the founding of the banking system and the Latin American debt crisis, a net loss was made by American banks. Integrating from then through the S&L crisis, another net loss. Integrating from then through the current crisis, another net loss. While individual banks may be profitable, the system itself has a long history of losses. Let’s spread commercial banking internationally!

  3. Mumbles in a drone sounding rhythm”Interconnectedness….. interconnectedness….. interconnectedness….. interconnectedness interconnectedness….. ” Whaaaaa! Looks up, befuddled and confused…… Did you say something James???

  4. Dimon is correct. Scale can provide value to bank shareholders beyond simply making them too big to fail: it can give large banks enough pricing power which in turns allows them to extract returns that exceed those available in a competitive market. I’m not about to expect him or anyone else connected with the bank lobby to publicly admit this, though.

  5. I think the main “artificial limit” here is whatever size the government lets them be, for their weal or woe, since their natural, “free market” size is bankrupt and gone.

    Let’s never forget we the people OWN THESE BANKS and have every right to do anything we want with them, any time we want.

  6. The sad thing is, a lot of people could switch to Credit Unions relatively easy. But they would rather buy a $1.50 candy bar with their ATM card, get charged $39.00 for an overdraft fee and then tell you it’s just too inconvenient to change accounts.

  7. Regulation Does Not Work; Financiers Are Smarter Than The Regulators

    From the Bank of Englend:

    The evolution of the banking and financial system has been accompanied by a growing support system from the public sector to the point where “Today, perhaps the biggest risk to the sovereign (state) comes from the banks.”

    Banks “game the state”, and exploit the state safety net. “State support stokes future risk-taking incentives, as owners of banks adapt their strategies to maximise expected profits. So it was in the run-up to the present crisis,” when banks adopted riskier strategies through a combination of increased leverage, proprietary trading, and by increasing the riskiness of their asset pool. The riskier strategies result in higher payoffs in good times and deep losses in bad times, “often cushioned by the state.”

  8. James, is it possible to create a derivative based on the number of major newspaper Op-eds Dimon does per year??

  9. Something that has been nagging at me about this is, bankers have shown quite a bit of herd behavior. If big banks are split into smaller ones but they all do the same things and all get into trouble again, are we really any better off in that case? The total size of the problem is still the same.

  10. At the risk of repeating myself

    1) Smaller banks will have more difficulty capturing their regulators and controlling our legislature (and executive).

    2) Smaller banks have simpler balance sheets. That makes them easier to audit for regulators and for investors. It makes it harder for them to hide outsized risks in “off-balance-sheet instruments”.

    3) Most importantly, as Rockfish points out below, is that TBTF institutions have artificially low borrowing costs. Creditors and counterparties know that they will always be made whole, so they have no reason to care if the firm is taking outsized risks. This is a distortion of the market that increases systemic risk. If we made sure that no particular firm was TBTF, lenders and counterparties would be far more likely to impose the discipline that they should have been imposing all along.

  11. Also, the size of the problem Isn’t the same. If 1000 smaller banks all behave like a herd and all go into financial risk, and we think letting them all collapse would kill the economy, audit all of them, save the best run, and let the crappy ones go out. As much as there could be herd behavior, not every bank manager is going to be making the same stupid decisions, some of these people like their bank and want to keep it around.

    The current situation, we are stuck saving all 1000 smaller banks.

    Also, smaller banks usually mean smaller bank manager salaries. If you have a smaller salary, you are less likely to be able to run the biggest bank in the world for a year, and retire for life (and have money for you and your kids and your grandkids to live off of), disregarding any long-term effects you placed on that huge bank. Smaller bank managers have to run their bank for years before they could retire. You make stupid decisions that require the kind of instant bailouts that were required here, you’re not going to retire very well, and will collapse your bank and livelyhood.

  12. “If big banks are split into smaller ones but they all do the same things and all get into trouble again, are we really any better off in that case? The total size of the problem is still the same.”

    There are herd and lemming effects, but at the same time there is safety in numbers. Even when the banks do the same sorts of things, they are very unlikely to do the same things. Look at the current crisis. Among the relatively few TBTF institutions there was a range of behavior. Not all of them held on to sub-prime risk.

    Also, as Nemo points out, smaller banks are easier to deal with than larger banks. Consider all of the meteorites and cosmic dust that comes to the Earth every day. Except for seeing an occasional shooting star, we do not notice. But if the same amount of matter came to the Earth as a single meteor, it would be a catastrophe. :)

  13. it depends. if all you do is manually deposit a check (by going to the bank) and haven’t started using internet banking. its a lot easier than if you are using those. and if you throw in credit cars and others features of that bank it get even harder

  14. “Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole.”

    i would think the value proposition would be stated with consumers first and shareholders second

    but maybe the money handling industry marches to the beat of a different drum

  15. James,

    You’re a frickin genius! I was hoping someone would pick up on the Dimon parroting of Calomiris.

    The fact that such a crap argument is propagating tells you how weak the case really is.

    Have a good weekend.

  16. Speaking of the truth…

    One of the big roots of our pre and current dicaments is capture — capture of industry and government. Most of this comes from the inability to vet people properly, and/or investigate them. Yves Smith posted a link that may be far more important than even she realizes. It talks about the state of electronic mind-reading. We are far far better at this than most people realize.

    Watch the 60 minutes video. The Carnegie Mellon fellow puts the estimate for when we’re able to read complex thought by machine, at 5 years. Watch carefully the fellow who says “we can’t do that yet, but we’re working on it.” (Paul Wolpe, Director of the Center for Ethics – Run! – at Emory University.

    Watch his eyes carefully when he says “we’re not there yet.” Is he being truthful?)

  17. Banks that are too-big-to fail, because of the damage they would cause, can hold the government(taxpayer) hostage, and set the terms of bailouts.

  18. In a bailout, the “big banks'” position is strengthened knowing that the Federal Reserve is tasked with ensuring the stability of the financial system, has a blank cheque, and little accountability.

  19. I don’t know that I agree James. A lot of marketing and sales folks will tell you that if you repeat the same thing enough times and loud enough, your audience will believe its true. Even if it ain’t true. Shout down your opponents, repeat repeat repeat, eventually the masses believe you and line up in your corner.

    Sadly, they’re right, and that’s exactly what Dimon is thinking I wager.

  20. No, that’s a piece of manure that’s tied to the value of another piece of manure. And if you have no capital you say “I’m to valuable to the economy, so you must pay for my manure”. Then when the government tells you you can’t sell manure the same way, you yell “socialism!!!”

  21. My post could have been misunderstood. I meant Kwak when I said James. I was referring to what the Treasury had said to the bloggers who promised the Treasury their quotes would remain anonymous. One of the propaganda stunts was selling “interconnectedness” to the bloggers.

    Of course Mr. Coffman’s views I respect.

  22. Once we agree that Too Big To Fail is a problem, how to we deal with it? I agree that an “arbitrary” limit on size is and anti-trust actions are inefficient. They also suffer from regulatory capture.

    An interesting proposal was floated several months ago to deal with TBTF. Increase reserve requirements as banks get bigger. This makes large banks less likely to fail, and lowers their opportunities for profit as they get larger. I don’t know what happened to this idea.

  23. “Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole.”

    Thus spoke Jamie Dimon, who, like Lloyd Blankfein, finds himself doing “god’s work” while a banker.

    I’m waiting for the op-ed piece where Dimon explains the benefits consumers have reaped thanks to the big banks. I don’t know a consumer who feels they’ve gained anything by the consolidation of the banking system.

  24. “Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole.”

    Let’s see, isn’t that MUTUALLY exclusive? I’m not a shareholder of Chase, but I have one of their credit cards, which recently readjusted to 29.99%.

    Good for Chase shareholders. But for me, as a “consumer”, I got a worse product, delivered quickly at HIGHER cost. For the economy as a whole, nah… don’t believe emptying my pockets to pay Chase has helped keep anybody in business in my town…

  25. If any of you work for a big company, you understand the fallacies of efficiencies, synergies, economy of scale, etc., that the MBA types like to trot out. They just don’t materialize. The bigger a company gets, the more layers of management, the more meetings, the more garbled top-down messages, the more “process management”, the more business trends du jour, the more alienated the workers become…need I say more?

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