Economics, Pethokoukis

Does the US economy really need supersized megabanks?

Image Credit: Federal Reserve Bank of Dallas

The bipartisan movement to break up America’s biggest banks and end the Too Big To Fail phenomenon has slowly, glacially gained momentum. Financial reform represents a classic public choice issue where the benefits of the status quo are concentrated and current — an ongoing federal safety net for a few major and politically powerful financial institutions — and the costs are diffuse and distant — the heightened risk of another financial crisis and future taxpayer bailouts. But the ball continues to move forward.

The argument for breaking up megabanks, restructuring them, or capping their size is this: Bigness plus bailouts have created what British bank regulator Andrew Haldane calls a “self-perpetuating doom loop.” The industry is so large, concentrated, and complex that the failure of any institution could create financial instability and thus major players receive an implicit government guarantee of their debt (a guarantee reinforced by the banks’ extraordinary political influence). The incentive, then, is to become even bigger and more complicated, raising the risk of financial crisis and further taxpayer bailouts.

The counterargument is ably and gamely expressed in a new report from Hamilton Place Strategies, the rising policy and communications consulting firm whose partners include my friend and fellow CNBC contributor Tony Fratto, the former US Treasury Department and Bush White House spokesman. Here are the key points from “Banking On Our Future: The Value Of Big Banks In A Global Economy”:

1. US banks are already smaller and safer than their global competitors.

2. The loan syndication market is no substitute for big, global banks.

3. In the event of a break up, the global competitive landscape will rebalance in favor of foreign banks and the shadow banking sector.

4. Ultimately, breaking up US banks will not improve the safety of the global financial sector and would reduce US influence over the financial sector globally.

For starters, is a relative standard good enough? The US has a more robust economy and job market than France, but is this sufficient? The largest European and US banks are all far bigger, in terms of asset size, than the $100 billion asset level that – some research suggests – may mark the point where economies of scale fade. The HPS study disputes that research but offers no guesstimate of where a ceiling may exist — or if one exists at all.

The HPS study is, I find, too quick to dismiss a) the idea that the size of these institutions may partly reflect government subsidy rather the result of market forces, and b) the idea that a continued funding edge by big banks over small might stem from the TBTF safety net. HPS also places unmerited faith in regulators and the Dodd-Frank financial reform law to out think the bankers and stay one step ahead of bank innovation — especially given the political power of Wall Street and the government-lobbyist revolving door.

And even if the new rules work as intended, are they enough? Take Dodd-Frank’s bank-liquidation rules. Harvey Rosenblum, research director at the Dallas Fed, recently told Bloomberg that they “could work in one isolated large failure, but anything beyond that would be extremely difficult. “We either have to cap their size or force these institutions to break themselves up.” And even in the case of an isolated large failure, might not fear of contagion nudge Washington to do whatever necessary to avoid that possibility? Again, history suggests governments do just that. Haldane:

Policymakers face a trade-off between placing losses on a narrow set of tax-payers today (bail-in) or spreading that risk across a wider set of tax-payers today and tomorrow (bail-out). A risk-averse, tax-smoothing government may tend towards the latter path – and historically has almost always done so, most notably in response to the present financial crisis.

The rest of the HPS argument concerns international competition. My short response: The US should lead the way in pushing for an international accord that would break up these mega-institutions into more manageable sizes, as Dallas Fed President Richard Fisher has suggested. But if the US has to go it alone, so be it. Does it matter if US multinationals get their funding from banks based in Manhattan or London? We don’t need to subsidize a jobs program at the US megabanks, especially one which may be siphoning our best and brightest to construct complex financial instruments or supersophisticated trading algorithms rather than breakthrough in genetics or nanotechnology or energy.

Still, the HPS study is a welcome addition to the debate and merits further analysis and response.

11 thoughts on “Does the US economy really need supersized megabanks?

  1. finally!
    I am so glad to read these words. I will summarize it as this: Too big to fail is too big to exist. America was built by individual ideas, not by corporate monster companies. Companies that are too big to be understood by one person, and therefore guided by a single CEO with singular ideas must go. No more monsters means when a bank goes down, I am not obligated to hold it up. Excellent article

  2. What I never get about the “too big to fail” talking points is how the obvious is never mentioned; The Federal Reserve is the only real bank and everyone else large or small is a branch. The assumption of the absolute power of the central bank systems is acceptance of too big to fail and makes all of these talking points very shallow and hypocritical. It’s just make believe to segment “banks” and to ignore the central entity that pulls all levers in the entire system and give that entity immunity. We should talking about breaking up central banks and replacing them with an organized private banking structure based on stable money (as opposed to the government inflation system at hand). To big to fail targeting only the actors (banks) is just another form of anti-reform political correctness for those who understand who has engineered the current levels of financial failures on a global basis.

  3. Those wonderful, big foreign banks are built on borrowed, printed money from their government sponsors. They will go pop! someday. So will ours, but for different reasons, if we let them continue to exist. Banks always manage to overdo it. We must be able to let the stupid ones die. Free enterprise requires the death penalty for businesses which fail.

    While we are at it, reduce FDIC insurance to $15k. Stop underwriting gambling through the banking system, and the dumbass banks which gamble.

  4. Does the US economy really need supersized megabanks?“…

    What the heck? Why not?

    Afterall the US economy is saddled with a trillion dollar welfare system

    To big to fail?

    Let’s face it, no one is actually being forced to use the mega banks, right?

    Yet we’re all forced to contrubute (ha! ha!) to the welfare system…

  5. A few huge banks would be real bad.
    1. “Too big to fail” does not mean it won’t fail it means that when one does fail it tanks the whole economy.
    2. Having a few big banks makes it easier for the government to control or take over them.

    Either way American loses.

  6. If the mega banks believe they need to continue being mega banks to stay competitive, that is okay with me as long as the American taxpayer does not have to rescue them again. However, as I understand Dodd-Frank, if they screw up again, the taxpayer will legally have to rescue them again. This is “capitalizing” the profits for the few mega bankers and “socializing” the losses at the expense of the American taxpayers collectively.

    • Thank you, JoyO. That was a rational comment. I am tired of some of the closet collectivists at AEI trying to use the existence of the bailouts which they advocated for as an excuse to impose antitrust on the banks. Some of these guys are really, really anti-free market and pro-government control and are searching for any little pretext to interfere in the markets.

      • WM, the reality is it was a socialist system long before the 2008 “Crisis”. That the focus is on individuals who exploit a system at hand or the going on about “big” banks vs. “small” when they are all part of a contained central banking system is beyond logic. The failure is based on government excess and broad socialist expectations of almost all participants. Why is this taboo to discuss?? Too big to fail is usually one of the most ignorant of financial debates when two of the largest participants (U.S.Government and it’s streetwalker the Federal Reserve) are always ignored.

        Add insult to injury that both Dodd and Frank should be in prison for their personal exploits relating to the financial system and the irony only grows. The financial system which is government based and failed only grew more powerful over the individual and markets since 2008. Why do why have to listen to these scapegoat arguments over and over about various participants from essentially guilty parties?

  7. Banks are slaves to the system at hand, the Federal Reserve and the government is what “too big to fail” really means. We should stop pretending, it’s a socialist failure already. Whining about “banks” is make believe outrage.

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