By James Kwak
“Big banks are bad for free markets,” economist Arnold Kling (who usually blogs at EconLog) begins in the conservative flagship National Review, and it only gets better from there. “There is a free-market case for breaking up large financial institutions: that our big banks are the product, not of economics, but of politics.”
Like other conservative economists, Kling uses Fannie Mae and Freddie Mac as an example of financial institutions that grew too large through a combination of lobbying expertise and government guarantees . . . and frankly I agree with him. But he is equally unsparing of other large banks that were supposedly “pure” private actors but turned out to have their own government guarantees.
Kling points to various government policies that have favored the growth of large banks. But rather than simply saying that this means that government should stay out of the markets, Kling says that the problem is one of political economy:
“In recent decades, the blend of politics and banking created a Washington–Wall Street financial complex in the mortgage market. . . . During this period, Wall Street firms were able to shape the basic beliefs of political figures and regulators, a phenomenon that Brookings Institution scholar Daniel Kaufmann has dubbed ‘cognitive capture.’ Andrew Ross Sorkin’s Too Big to Fail, which describes the response of the Federal Reserve and Treasury to the financial crisis, leaves the distinct impression that senior bankers had much more access to and influence over Washington’s decision makers than did career bureaucrats.”
Kling’s answer: make the banks smaller. I agree.
Jonathan Chait has an interesting take on Kling:
“I agree with Kling that the ideal solution would be to simply limit the size of the banks. The second-best solution, which is currently being pursued by Democrats in Congress, is to regulate the banks to prevent them from engaging in risky behavior, and/or tax the large ones to reduce the advantage they gain over small institutions that aren’t too big too fail. . . .
“[The large banks] already have so much political power that breaking them up has zero political feasibility. So we’re in a second-best world where it’s regulate, and hope regulation works, or do nothing. My skepticism of Kling’s argument is that, like some principled right-wing arguments that acknowledge climate change, it argues for an ideal solution that lacks any chance of happening, while favoring the status quo over a second-best solution.”
Chait’s point makes sense, but insofar as I have to take sides, I’ll take Kling’s. First, as a general point, I think that it’s not quite fair to hold economists or policy commentators up to a rigorous standard of political feasibility. It’s not like Kling is proposing a legislative strategy for the Democratic majority; he’s just saying what he thinks policy should be, and his proposed policy isn’t impossibly infeasible like “everyone should just be nice to each other.” I’m sure we could have an endless debate in the blogosphere about the relative merits of the ideal and the achievable, so I’ll stop there.
Second, I’m not sure that Kling says he would favor the status quo over more regulation of the sort proposed by the administration. In any case, I certainly would not, and when I criticize the administration for not going far enough, I generally try to remember to say that they are going in the right direction. Simon and I also take pains to say that simply breaking up big banks is not enough and other changes such as higher capital requirements (and a CFPA, which we write about to the point of boring our readers) are also necessary.
Finally, Kling’s goal may not be achievable in this session of Congress, but it may be achievable in the next decade. It takes time to shift public opinion away from the idea that big banks are inherently good. But it’s still the good fight.
Update: Tom Keene asked us how we managed to get book endorsements from both Dean Baker and Jim Bunning. I said that this just shows how opposition to big banks is not a simply partisan issue. Kling’s article spells out why many supporters of free markets–the economic “right”–are opposed to big banks.
The Baseline Scenario 
Until we get rid of the Fed. everything else is meaningless, esoteric crap. You’re just wasting your & our time.
Agree with Kling. Bing banks are too risky for the economy, and benefit a few people. Long live capitalism. Down with big banks.
[The large banks] already have so much political power that breaking them up has zero political feasibility. So we’re in a second-best world where it’s regulate, and hope regulation works, or do nothing. My skepticism of Kling’s argument is that, like some principled right-wing arguments that acknowledge climate change, it argues for an ideal solution that lacks any chance of happening, while favoring the status quo over a second-best solution.
Jonathan Chait was one of the worst of the lying hacks who Astroturfed for the reactionary health racket bailout.
And now today they’re serving up the exact same Big Lie.
The lie there was the same as here. Single payer was both easily politically achievable and was the only thing which actually would have both lowered costs and extended and improved coverage and care. The sellout bill will do none of those and make all of them worse, while adding the tyrannical mandate as a veritable act of government war on an impoverished people.
If everyone who ever claimed to want reform had simply demanded single payer, we’d have had it. AT WILL.
But the fact was that Obama, the Democratic Party, and their hacks starting with Krugman and on down through Chait and the rest of the gang never wanted real reform. They wanted an insurance racket bailout. So they lied about wanting reform, lied about the political impracticability of single payer (where the one and only reason it wasn’t politically achievable was because liars who claimed to want reform DIDN’T WANT REFORM) pulled their “public option” bait-and-switch to fool the liberal teabaggers, and the rest is history….
So today, as that lying quote displays, we’ll have a replay. Obama has proven since day one that his priority is to help Wall Street loot the country and protect it from even meager “reform” let alone real reform. So obviously, as with single payer, the one and only reason breaking up the banks is being called “not politically feasible” is because OBAMA AND THE DEMOCRATS DON’T WANT REFORM.
If they wanted to break up the banks, they’d break up the banks. If Obama wanted to side with the people, he’d side with the people. He’d have done so from the start, instead of joining in their affliction from the start.
(The same goes for banning speculative derivatives, establishing a powerful independent CFPA, and other real reforms. Obama doesn’t demand them because he doesn’t want them. Like with all other reforms, anywhere, everywhere, he OPPOSES them.)
So the goal here is to pass another phony “reform” bill and lyingly proclaim it another great “victory” when it in fact reforms nothing and further entrenches organized crime. While the Frank bill or what’s being cobbled together out of garbage in the Senate may not add a truly vile new assault like the mandate, they still confirm, entrench, enshrine, affirm the existing rackets, existentially and in all their worst practices. These bills also affirm the official government ideology of corporatism (the economic form of fascism) and trickle-down.
(Need I add what I’ve said a hundred times, what has been proven beyond any doubt at all by now, that regulation cannot work where these rackets exist at all. That’s what proves only single payer could possibly have been practical if you actually wanted reform, and it proves that only smashing the banks can have any chance at all of achieving reform, while anyone who says the opposite is simply repeating the lie already disproven with the phony “stimulus” and now with health care.)
In those ways this “reform” bill is another massive step in the wrong direction, far worse than doing nothing. Even Hack Number One Krugman was saying “kill the finance bill” not long ago. (But as Chait shows, the liberal fascists have no lack of gutter hacks to try to do their lying and Astrofutrfing for them.)
So we have the same criminal scam from the same criminal gangsters on behalf of the same criminal system.
The people’s only hope is for them to recognize once and for all that Obama, the Democratic party, and the entire liberal hack leadership are all worthless liars and betrayers, every bit as much as the Republicans. That these are equal participants in what is now a rogue government, a complete and irredeemable kleptocracy.
Only then will the people start to look for real reform, real politic, real morality, and real justice in the one and only place they’ll find these, out of themselves, and imposed by themselves, from the bottom up.
Forcing large institutions to hold disproportionately more capital would have the same effect, as I wrote here:
http://alephblog.com/2010/03/16/dumb-regulation-is-good-regulation-how-to-regulate-the-banks/
I agree, break up the big banks, but take it further, limit their ability to invest in each other, whether debt or equity, so that contagion is contained.
I see John Dugan at OCC is licking big banks’ hindquarters again. America will be a better place the day he gets replaced. Does Dugan think changing public positions in a very fake and phony way late in the game will make him look like any less of the ABA brown-noser we all know he is??? Dugan and Dick Shelby should get a private room together.
http://www.huffingtonpost.com/2010/03/31/top-bank-regulator-change_n_519173.html
You are absolutely 100% right. I was just talking to some close friends about this tonight, and it seems the only intelligent answer is that which you so well explain again here. Why is it that people think the proper thing to do is so politically difficult? It’s not, if you really want to do it. But Obama, Geithner, and Summers obviously have no real interest in doing the right thing, from the bailout scandal to healthcare reform. In fact, if people actually took a real look at this, it’s more hard-right, quasi-fascist than most right-wingers would advocate.
Forcing me to buy insurance? Forcing 32 million new customers into the waiting arms of the insurance companies without a public option as fair ballast? Good God Obama!!
What a colossal joke.
Great post Russ. Way to kill a thread though, there is literally nothing to add that’d improve on your comments (well, I guess we could beat up on Chait some more). :o)
If the administration was even remotely serious about financial reform all the crooks who violated Sarbox would be doing the perp walk.
Instead, two administrations, one Republican, one Democrat, bailed out the criminals and paid these criminals bonuses.
We’ll get reform alright.
“when I criticize the administration for not going far enough, I generally try to remember to say that they are going in the right direction.”
When you say they are going in the right direction you lend aid and comfort to an enemy which should be exposed relentlessly for what it is. They are not going anywhere with their two thousand page reform bill which will not change a single existing financial practice, reduce the dimensions of the next bubble, limit the destructiveness of the next crash. Keep cheering for lipstick on the pig and doing those guest appearances on the news hour. Sell some books; congratulate yourself for tasteful moderation.
Obama today is using the ‘we’d go bankrupt’ if we didn’t use his health care solution..um, sell out. Freaking coward, using the same extortion tactics of GW and Paulson.
Anyway, great post Russ, and thanks for exposing Krugman and his new found ‘celebrity’ standing. With his fame-basking and Obama’s ‘legacy’ crap, we’re in very good hands…
Do you think Krugman is taking a shot at you guys?:
http://krugman.blogs.nytimes.com/2010/04/01/too-big-to-fail-fail-great-depression-edition/
Financial Reform 101
April 1, 2010 – Paul Krugman – NY Times – excerpt
“So what’s the alternative to breaking up big financial institutions? The answer, I’d argue, is to update and extend old-fashioned bank regulation.
After all, the U.S. banking system had a long period of stability after World War II, based on a combination of deposit insurance, which eliminated the threat of bank runs, and strict regulation of bank balance sheets, including both limits on risky lending and limits on leverage, the extent to which banks were allowed to finance investments with borrowed funds. And Canada — whose financial system is dominated by a handful of big banks, but which maintained effective regulation — has weathered the current crisis notably well.
What ended the era of U.S. stability was the rise of “shadow banking”: institutions that carried out banking functions but operated without a safety net and with minimal regulation. In particular, many businesses began parking their cash, not in bank deposits, but in “repo” — overnight loans to the likes of Lehman Brothers. Unfortunately, repo wasn’t protected and regulated like old-fashioned banking, so it was vulnerable to a pre-1930s-type crisis of confidence. And that, in a nutshell, is what went wrong in 2007-2008.
So why not update traditional regulation to encompass the shadow banks? We already have an implicit form of deposit insurance: It’s clear that creditors of shadow banks will be bailed out in time of crisis. What we need now are two things: (a) regulators need the authority to seize failing shadow banks, the way the Federal Deposit Insurance Corporation already has the authority to seize failing conventional banks, and (b) there have to be prudential limits on shadow banks, above all limits on their leverage.
Does the reform legislation currently on the table do what’s needed? Well, it’s a step in the right direction — but it’s not a big enough step. ”
Krugman writes today(2 Apr):
” So what’s the alternative to breaking up big financial institutions?
The answer, I’d argue, is to update and extend old-fashioned bank
regulation.”
And I, a non-Nobel-prize-winner, would argue: Let’s
do both. Does Mr K really think that his “alternatives”
are exclusive?
I’ve written before, in my Johnny One-Note mode:
Money is Important. Regulate the people who “issue
it”(aka banks) like mad. (Variants on this theme:
“make banking boring again”)
Best wishes to all,
Alan McConnell, in Silver Spring MD
Do you ever think about previous lovers?
Looks like nobody here will stand up for putting criminals behind bars. If there’s a God it’s time to conduct another search for Lot. Otherwise, our best hope is complete collapse and rebuild.
The point is not that they are criminals (that is self-evident). The point is that they are our criminals.
No one is really concerned with improving people’s lives or building a future for our country. All we care about is who is winning. As long as our team comes out on top, we don’t care how many illegal hormones they use or whether they clandestinely videotape the other guy’s practices.
Go Team!
“Finally, Kling’s goal may not be achievable in this session of Congress, but it may be achievable in the next decade. It takes time to shift public opinion away from the idea that big banks are inherently good. But it’s still the good fight.”
I think this is wrong. True, the political job of holding the banks responsible and punishing them would have been easier when the first wave of anger at the economic meltdown and the pain it caused was felt. But the public is still very receptive to the message that big banks are not inherently good, that in fact they’re acting as an enormous gambling casino where the house always wins and the small fry always pay. They’re not so enamoured of economic theories such as “trickle-down” or “high taxes on the wealthy limit investments in businesses that create jobs” as they were in the recent past. They see no benefits from the economic games being played on Wall Street trickling down to the middle class (much less the poor), and investments by the wealthy are understood to be going back into the casino, not building plants and buying equipment and hiring workers.
If we had leaders on the side of the people instead of appeasers and apologists for an economic system that’s proved to be a failure for the great majority of the public, it would take very little persuasion for those leaders to get the public behind them in taking bold steps to transform our economy and make it work for all of society.
Unfortunately, as has been stated before in this thread, we do not have those leaders now. What reformers there are who are willing to call the economic system what it is – an unholy game of bait and switch – have no power.
thats right.
While I don’t think this is a waste of time, you are otherwise correct.
Did I get blocked on here again????
So, my agreement is that we need to act agressively against the TBTF institutions. My question is: who is going to shoulder that task? And, really the question is: who is non-partisan enough in his approach to Congressional cohesive enough to get our legislators to do what 99% of the public wants? To get rid of Wall Street as it currently exists (for the sole purpose of robbing us blind and keeping the power to do so ad infinitum).
Declaring an academic’s inherent right to spin out nostrums ex cathedra, James Kwak writes, “First, as a general point, I think that it’s not quite fair to hold economists or policy commentators up to a rigorous standard of political feasibility. It’s not like Kling is proposing a legislative strategy for the Democratic majority . . . .” –If not by legislation, now or later, how will this plan be implemented? And why is the legislative process immune to the best plan? Do class/political forces cease to exist simply because they are not allowed in the academic seminar?
I am so old that I remember when “liberal” was mainstream. I remember the crackpot right complaining that the capitalists weren’t acting like real capitalists. The National Review’s Arnold Kling, waving the defunct banner of “free markets,” is a throwback to these folks, like vestigial chicken teeth.
I’m glad I saved my Confederate money . . . .
I didn’t save a copy of the letter I wrot3 to Krugman, but my main problem with his stance was that the analysis had a narrow frame work. (only systemic risk)
1) I addressed the outsize role a few firms had on policy choices
2) While smaller firms may face a bail out, they don’t know they are too big to fail and this should moderate risky behavior. In our current system those who are too big to fail know it
3) pricing power in the market. a few big firms decrease competition and cause consumers to pay more. finance is basicly moving money from one location to another. therefore the costs associated with it shouldn’t be high. they are middle men. having a few forms causes excessive profits. think about the bid rigging of the mubi market
4)the function of the maket place. when few firsm have all the power in the market place they have the potential to distort that market at will. think stocks. the market functions better of many smaller firms trade to make up the volume. if few forms make up large percent of volume they can manipulate and create distortions
5) I mentioned that often government gets people moving in and out of wall street. did having so many goldman people cause us to give aig 100 cents on the dollar, does having everyone come from the few places alter the way of thinking and policy of our institutions.
the concept of limiting the size of a financial institution has its own attractions. of course, as always, the devil is in the execution. there is plenty of academic work on whether size matters for efficiency. no conclusive evidence. surprised? more to the point, in the financial sector, size is most difficult to define. Misterious diseases like kurtosis and skewness are hard to measure, never mind manage. correlations have proven to be more an art than a science. and how about managing the interlinks between financial institutions? in the house of cards of financial markets are we sure that managing the links between a plethora of mid size players will be any easier than checking on a few semi-giants?
I confess i don’t have straight answers to my own questions.
good luck to the regulators. and to all of us!