By Simon Johnson
Global megabanks have had a tough summer. Jamie Dimon, vociferous opponent of restrictions on reckless risk-taking by big banks, presided over large losses due to exactly such behavior in the London office of JP Morgan Chase. HSBC, which prided itself on running a uniquely decentralized management model, was found to have violated – massively, over many years, and in a uniquely decentralized manner – US money laundering and other laws; the head of global compliance resigned while on the witness stand during a Senate hearing in July. And Barclays – which had bulked up on the strength of its capital market activities – conceded that traders from that part of the company had conspired to rig Libor, a key benchmark for global interest rates; in the ensuing public outcry, the top two executives were forced out.
And last week Sandy Weill, who amassed a vast fortune building Citigroup and pushing to dismantle the constraints on such megabanks’ activities, concedes that the entire exercise was a mistake.
“I’m suggesting that they be broken up so that the taxpayer will never be at risk, the depositors won’t be at risk, the leverage of the banks will be something reasonable,..”
According to American Banker, former top executives calling for the biggest banks to be broken up now include Phil Purcell, former chief executive of Morgan Stanley; John Reed, former chairman of Citigroup; and David Komansky, former chief executive of Merrill Lynch. (I am asking American Banker to bring their slide show on this issue out from behind their paywall.)
Backed into a corner, representatives of these Too Big To Fail banks and their allies are forced to fall back on perpetuating three myths.
First, their critics are “populists” who do not understand banking or economics. But this is belied by the credentials of the people raising serious issues with how global megabanks currently operate. The American Banker highlights the critiques of Richard Fischer, president of the Dallas Fed (and experienced financial sector executive), Tom Hoenig (former president of the Kansas City Fed and currently number two at the Federal Deposit Insurance Corporation, F.D.I.C.), and Sheila Bair (former head of the F.D.I.C. and now chair of her own Systemic Risk Council – of which I am a member.)
As I wrote here last week, Fed Governor Sarah Bloom Raskin has emerged as an important voice calling for rethinking key aspects of big banks, including why they should have implicit government backing for their securities and trading operations. Mervyn King, governor of the Bank of England, and Jon Huntsman, former Republican presidential candidate, have also expressed articulate and well informed proposals for making big banks less dangerous – primarily by forcing them to become smaller.
In this context, you should read Neil Barofsky’s new book, Bailout, a compelling critique of how the bailout process was handled, including the treatment afforded to banks and the relative lack of effort that went into directly addressing problems with mortgages. The pushback from the Obama administration is that Mr. Barofsky is some form of populist – in contrast with the supposedly responsible professionals of the Treasury Department (many of whom were previously or have subsequently become employees of large financial firms).
But a close reading of Mr. Barofsky’s narrative and analysis confirms what was evident to anyone who studied the reports he produced when he was Special Inspector General overseeing the Troubled Asset Relief Program (or SIGTARP, in the jargon). Mr. Barofsky is a distinguished law enforcement professional who was given the job of preventing fraud and abuse in the congressionally-mandated bailout program. His efforts to ensure TARP was run effectively and more in line with taxpayer interests were opposed by senior Treasury officials almost at every turn.
The true issue is not populism vs. responsible bankers. Big banks have become a dangerous special interest with powerful friends. It is the reformers who are responsible. Executives who run megabanks – and anyone who supports their continued existence – are the ones who have become reckless and damaging to society.
The second myth is that a “cost-benefit analysis” would show that the Dodd-Frank financial reforms are not worth pursuing. This is actually a clever – or perhaps devious – legal strategy that is being pursued in a low profile but effective manner. Even well-informed people in Washington frequently have no idea how much damage this myth can still cause within the rule-writing process.
Fortunately, Dennis Kelleher and his colleagues at Better Markets are fighting hard against this myth. In a report released this week, Kelleher, Stephen Hall, and Katelynn Bradley point out that the industry never wants to take into account the real costs of the crisis – millions of jobs lost, growth derailed, lives disrupted, and massive damage to our public finances.
We had a frank discussion of this report at the Peterson Institute on Monday, and I was struck by how many people have a hard time getting their minds around the scale of the damage wrought by large financial institutions that got out of control.
This relates also to the third myth – which is the claim that financial reform will hurt our growth prospects. Again, as laid bare by Better Markets, it was reckless risk-taking at the heart of our financial system that led to the largest crisis since the 1930s; the damage will be with us for a long time.
Some dramatic government actions helped to reduce the impact on the real economy – and we avoided a Second Great Depression.
But, as Neil Barofsky makes clear, there is almost nothing about these bailout measures that should make you feel good. Putting the big banks back on their feet, with essentially no conditions requiring real change, was a mistake – reinforcing the moral hazard and implicit government subsidies that are now at the heart of our financial system.
Today’s global megabanks are too big to manage. It is not “the market” in any sense that keeps these firms at their current scale; this is the largest and most dangerous government subsidy scheme on record. Such subsidies can only be ended by government action – it is time to break up the largest banks. Make them small enough and simple enough to fail.
An edited version of this post appeared yesterday on the NYT.com’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.