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.