In my recent podcast with economist and columnist Simon Johnson, we chatted about his idea to place size limits on banks. But how do you begin to calculate how big is too big? In the past, Johnson himself has recommended a 2% of GDP cap on liabilities, which would mean no bank in America would have more than about $300 billion of liabilities. He also adds this back-of-the-envelope calculation:
What is the right number: 1%, 2%, or 5% of GDP.? No one can say for sure, but it needs to be a number so small that we all agree any politician who cares about our future would have no qualm letting it fail, and when doing so have confidence that our entire financial system is not at risk as it fails.
But it’s not just Too Big Too Fail that’s the issue, it’s also Too Big Too Manage. Some research has suggested economies of scale can be found for banks with balance sheets of $1 trillion or more. Yet as a Bank of England study points out, that conclusion fails to break out the implicit subsidies associated with TBTF. These subsidies, as the BOE’s Andrew Haldane explains, “tend to lower funding costs and boost measured valued-added for the big banks. In other words, the implicit subsidy would show up as economies of scale.”
Back out those subsidies, and evidence of scale economies for banks with assets in excess of $100 billion “tends to disappear. Indeed, if anything, there may even be evidence of scale diseconomies, perhaps consistent with big banks being ‘too big to manage.”