By Simon Johnson
“Breaking up big banks would actually increase system risk” is a refrain heard from top administration officials, ever more vocal after they helped kill the Brown-Kaufman amendment (that would have limited the size and leverage of our largest banks) on the floor of the Senate.
But while Mr. Geithner and his colleagues are still taking their victory laps and congratulating themselves on retaining “business as usual” after the biggest crash-and-bailout in world financial history, educated opinion starts to feel increasingly uncomfortable.
People who worry seriously about system risk break the problem down into several distinct buckets, including the nature of shocks and the way these are propagated across the system. In this typology, the “Chuck Prince problem” is in a class of its own.
It might be fairer to label this issue as the Royal Bank of Scotland problem – because RBS had a balance sheet that reached roughly 1.5 times the size of the British economy before it failed. Or perhaps we should call it the Irish problem – three banks with combined assets around 200 percent of the Irish economy, and then they failed. Or even the Iceland problem – three banks that were 11-13 times the size of the Icelandic economy before they went belly up.
But all of those overseas examples still seem rather esoteric to American audiences – at least, that’s my experience after presenting 13 Bankers: The Wall Street Takeover and The Next Financial Meltdown over 50 times to audiences around the US over the past few months. Recent European experience points to our likely future – huge banks that herd into bad mistakes and, when bailout time comes, further imperil states that have already weak fiscal positions. But most Americans are not quite willing to say we are there yet.
So we will stick with the Chuck Prince label. The point is that while many banks are run by good risk managers for a while, they all eventually end up in the hands of someone who does not really know what is going on.
Banks are bureaucratic power structures, after all, albeit ones that try to make money after some fashion. The people who rise to the top are not always the most risk averse – more likely they get on with the boss or reflect someone’s glory in an appropriate manner or are just not that threatening to the people who matter.
Under our existing rules, good managers can build up banks and – with the continuing lack of effective cap on the size of big banks – these institutions can become huge relative to the economy. And then Chuck Prince gets the job.
The interesting thing about Mr. Prince, of course, is that he does not claim to have known what was going on. In fact, in his testimony to the Financial Crisis Inquiry Commission he rather emphasized that he was not fully informed or otherwise aware of the risks being taken by Citigroup – which he headed.
This “Chuck Prince” problem is exactly what would have been addressed by Senators Ted Kaufman and Sherrod Brown. And it is exactly what this administration ducked. Find me a systemic risk expert – and I’ve been talking to the very best – who thinks what the administration did was a good idea.
The next time a megabank fails, do not send to know for whom the bell tolls. It tolls for Tim Geithner and Larry Summers (as well as probably 25 million or so people around the world who will lose their jobs in the ensuing recession). Failing to break up the biggest banks was a policy mistake for the ages. Senators Brown and Kaufman handed this opportunity to Treasury on a platter – but they knocked it over, trampled it into the ground, and now brag about their feat to the press.
This was pure hubris on the part of the administration, with perhaps some NIH (“not invented here”) thrown in – if they didn’t invent an idea, they can’t believe it’s worth pursuing.
The next time a big bank crashes and burns – causing vast economic damage – you can blame Chuck Prince (or his latest incarnation) if you wish. Or you can blame the people who hired the Chuck Prince-equivalent. But I would respectfully submit that most of the blame lies with the folk who thought it was OK to continue allowing the existence of megabanks that can be mismanaged into utter disaster.
The “Chuck Prince” problem is a completely unnecessary source of system risk that could have been removed by this administration.