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.