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Too Big To Fail
Last night I made the argument that focusing on crude firm size wasn't the right way to look at our current banking crisis. It's the overall industry size that's important, not the size of individual banks.
But if you disagree, James Kwak makes about the best case for the prosecution that I've seen yet, suggesting that a financial industry with lots of midsize companies would work just fine:
What would such a world look like? There would be a lot of small- and medium-sized banks that collected deposits and lent money to households and businesses. There would be brokerage and asset management firms that you used to invest your savings. There would be hedge funds and private equity firms that rich people and other institutional investors used to invest their money. There would be investment banks that helped companies issue equity and debt securities. There would be boutique firms that did research and other boutiques that M&A advising. For any financial service anyone wanted, there would be a company that provided that service; it just wouldn’t necessarily provide every other service, and it wouldn’t have $2 trillion in assets. It would look something like the 1970s.
What’s wrong with this picture? Some people would argue that it would limit financial innovation....Some would argue that costs would be higher, because smaller firms would be less able to capture economies of scale and scope....To some people, the idea of size caps will seem anti-capitalist (or even un-American)....
Kwak addresses all of these issues fairly persuasively. But to me it still has the flavor of a solution that's clear, simple, and wrong. After all, Bear Stearns was a quarter the size of Citigroup, and it was considered too big to fail. So just what would the limit be on bank size? $500 billion in assets? $200 billion? Can a country the size of the United States even have nationwide banks with limits like that? And what happens the next time around, when all these smallish banks overleverage themselves and collapse en masse? Are we any better off than we are with a few big banks failing?
The whole post is worth reading, but I have a feeling that nostalgia for the 70s just isn't going to work. Big companies are here to stay, and I suspect that any regulation stringent enough to keep banks small enough to fail won't be sustainable. And unless we reign in overleverage and massive waves of credit expansion, it won't do any good anyway. The same thing will happen again, just in a slightly different way.
maybe not
The guy at Bronte Capital thinks not...
http://brontecapital.blogspot.com/2009/03/watch-those-baskets-why-citigroup.html
Felix Salmon says:
http://www.portfolio.com/views/blogs/market-movers/2009/03/30/why-big-banks-should-be-smaller
"I'm with James on this one. Two things are worth noting about Bear Stearns: first, it might have been small by Citigroup standards, but its balance sheet was still enormous. And secondly, it wasn't considered too big to fail, it was considered too interconnected to fail, largely as a result of its role as a major CDS broker.
To get specific, I think that maybe $300 billion in assets would be a reasonable cap on bank size -- there's very little evidence that banks get any economies of scale beyond that in any case. If they want to be part of a global or even a national network that would be fine -- I'm sure such networks would spring up quite naturally, much as they have in the airline industry. After all, the United States managed to go 200 years without any nationwide banks, it's unclear why it desperately needs them now.
At the same time, the cap on the balance sheet of broker-dealers should be smaller still: the more interconnected you are, the lower the cap, to the point at which companies like the CME, which are far too interconnected to fail no matter how small their balance sheet, should be barred from issuing any liabilities at all.
As for what happens when lots of smallish banks overleverage themselves and collapse en masse, well, you get an S&L crisis. Which is fiscally painful, to be sure, but which can largely be avoided through good regulation and which more importantly doesn't have anything like the systemic implications of the current meltdown. So yes, we're better off with one of those than we would be with Citi and BofA both failing.
The problem is a practical one: how do we get there from here. There are no good and politically-feasible answers to that question. So in the real world, TBTF banks are here to stay. But that doesn't mean we have to like it."
to clarify
The guy at Bronte Capital (highly recommended, BTW) thinks the Aussie model is a good one. Banks are huge, few, and heavily regulated. Banking is secure, dull but very profitable. The really whip smart folks do not gravitate to finance, it's too dull. There is no need to jack up leverage or create new financial weapons of mass destruction. Business is just fine without it.
Population
Canada's model is similar. But both are much smaller in size. The same ratio of institutions to population as Australia would result in ~60 large banks, not 4. And the US big four already have something like 2/3 of the deposits. I think the current system is fairly appropriate for the US.
Also, I don't think Oz has our wonderful system of
legalized briberycampaign financing. Banking, more than most other industries, can increase its profits by having regulations altered. More concentration would just increase the pressures on politicians to relax any improvements that the Obama administration makes - if any.But I agree with him on making banking boring.
Software companies are
Software companies are getting smaller. Publishers are getting smaller. Even manufacturing companies are getting smaller by partnering better.
In the realm of banking, what precisely does largeness provide?
1. Provides barrier to entry
2. Provides cushion against competition
3. Justifies huge overpaid salaries
...
<Insert Kevin Here>
How about a reasonable
How about a reasonable definition of the relevant industry, some reasonable way to measure it, and a limit on the percentage of the industry that one firm can be (say, no larger than 1% or 3%). Then no need to update it for inflation, etc., etc. Probably still necessary to revisit the industry definition every 15-20 years, but...
Um, Glass-Steagal for
Um, Glass-Steagal for starters?
Size per se does not need to
Size per se does not need to be controlled. It is function of what banks are allowed to do with deposits. If banks are returned to their proper functions through law and regulation, size will be controlled naturally.
Keep it simple
As others have pointed out, smaller institutions also pose systematic risks, so size isn't the issue. Some Thatcherite/Reaganite diehards will argue that more transparency is the answer since that would allow markets to operate optimately, but most commenting here don't buy that and know that more regulation is necessary.
That's why we need firewalls between financial industries. No one can run a financial supermarket nor can anyone regulate one. It's too complicated. It's not a theoretical argument, it's a practical one. You can make a valid argument for economies of scale when it comes to banking, but I have yet to see a good one for one-stop financial shopping, and the conflict-of-interest argument is a pretty compelling case against it.
I actually think large banks in the U.S. that are not too reliant on a specific regional economy makes sense. But they should be heavily regulated, and not involved in other financial operations.
Size = antitrust
tagged as:- solution
"So just what would the limit be on bank size?"
Maybe that's the wrong question. Maybe the right question is "how big does a financial firm have to be before the government is willing to make it explicit that they will not be rescued if they fail?" That would make size self limiting.
I think size, in the sense of becoming too big to fail, is worthy of making an antitrust issue, and telling firms, on a proposed merger, "go ahead, but if you go belly up you are on your own." And making that judgment very public so the market can render its verdict on the merger. Make size self-limiting, unless someone has an obviously good thing.
And Simon Johnson
who calls this a "quiet coup"
http://www.theatlantic.com/doc/200905/imf-advice
Simon Johnson Should Be Treasury Secretary
tagged as:- solution
Thanks, Hokuto. Excellent article.
The problem isn't how big
The problem isn't how big the institutions are, it is how steep the pyramids are. They are all pyramid schemes, as recent events have shown, concentrating wealth towards the apex. Pyramids that are too steep aren't good for the guys at the bottom. So the question to ask is how one can limit the difference between top and bottom.
The tendency of decision-makers to channel wealth towards themselves is also a source of problems, especially in large institutions where wealth moves through in huge volumes. Keeping them out of the top of the pyramid would help, but it's probably not practical.
So, obviously, smaller pyramids can't get as high, and this would be a good start.
The idea that big companies are here to stay is naive - nothing is here to stay, everything changes.
The effective policy of the
The effective policy of the government since 1980 and that of the Fed since its inception has not merely been to allow banks to get bigger but to encourage the process. They continue to encourage takeovers and mergers up to this moment. If the government takes over banks and later offers their assets back to the private sector they are usually bought up by the bigger banks. This happened after the crisis of the 80's and it is going on right now.
The big bankers and their many supporters in government talk about free markets, but what they are actually working towards is monopoly and/or plutocracy.
Not Size But Activities
tagged as:- solution
The problem isn't the size based on assets -- which is probably the silliest way of trying to restrict a company -- but on what they're legally allowed to do.
The solution is so simple, people are playing games trying to ignore it: Bring back Glass-Steagall!
www.LiberalMinded.org
Sorry, This Has To Be Said
Sorry but this is moronism of a high order. The fact that leverage also needs to be fixed or that small banks can still fail widely is irrelevant: leverage regulation is necessary but INSUFFICIENT!
Huge firms mean huge concentrations of power that no regulatory agency will be able to oppose; huge firms mean overwhelming monopoly practice. When credit card interest rates were above 18% your checking account gave you 0%; your credit card late and overlimit fees go up every month with those little statement inserts--even though credit cards are the most outrageous windfall to the banks in the history of banking; your ATM charges $3 dollars for other-bank cards even though switching from tellers to ATM saved the banks MASSIVE amounts of money. These things are criminal acts in restraint of trade. You can't "take your money to a competitor"; all the small banks get bought up by the big ones in weekly mergers, and the big ones collude to charge these usurious fees. These things could not happen if ordinary antitrust due diligence was done, but it cannot and will not be done because the individual institutions are too powerful.
Breaking up ATT did not end life as we know it, and all sorts of innovation resulted. These institutions are at least as monopolistic, with about a million times bigger sense of entitlement.
You know, this system is supposed to work through competition. When one company insures all banks in the world and pays a living nullity hundreds of millions of dollars to bankrupt it, do you think there is much competition happening? Do you think Vikram Pandit would feel as confident perjuring himself before Congress on national TV if his bank were not one of a few gigantic cancerous hypertrophies on the national economy? The reason you want many small banks is so they COMPETE with each other. The leverage, the systemic failures, are irrelevant to the fact that if banks are so big they don't need to compete they will automatically begin to commit crimes.
If the size of these institutions is not reduced, you can kiss this economy goodbye along with any hope for a balanced society and a GDP that actually means anything.
What a mind-numbingly stupid, unbelievably regressive notion: oh, just let a few megabanks run the country into the ground again and again. Uh, those charts on TPM showing the end of worker wage increases and the start of massive overvaluing of financial jobs and the twisted edema of the finance industry relative to the whole economy--those ALL coincide with Reaganite merger sociopathy. For a reason.
Kevin, you keep wondering why workers' wages have been flat, pointing out that unions would help restore balance even though they have their own problems. Don't you see that these massive concentrations of corporate power are a huge part of the problem?
The fewer banks, the more
The fewer banks, the more risk associated with each one, assuming they aren't all slavishly copying each other, which is also more likely with fewer banks.
Do we need so many small branches, like a Chase bank on every corner?
Too Onerous To Bother
tagged as:- solution
I remember seeing a suggestion at voxeu.org that proposed a system of increasingly stringent oversight the bigger a financial institution became.
In the most extreme cases I can imagine a scenario with in-house teams of regulators from the SEC monitoring the institution 24/7.
In this way there is a tangible cost associated with the 'moral hazard' of being an institution that is 'too big to fail' - and in which there is a tacit government guarantee in the event of a serious crisis.
In this way 'too big to fail' becomes 'too onerous to bother', providing an incentive for financial institutions to avoid the costs associated with growing large enough to pose a systemic risk should the institution fail.
The banks may lose economies of scale and scope, but on the flip-side the benefits for competition may make up for it.
Too Small to Care (.. you know, nation-wise...)
There should be inter-related disciplines in university Economics and Poly Sci departments studying what to to with Too-Big-To-Fail things (banks, industries, GM, or something else.) People studying these problems will develop better and better solutions, some of them proactive, i.e. heading off too-big-to-fail problems before they erupt. Bottom line, whether it's banks or an industry, this is a Too-Big-To-Fail problem.
Time for some trust busting
tagged as:- solution
The crux of Kevin's argument seems to be here:
"Big companies are here to stay, and I suspect that any regulation stringent enough to keep banks small enough to fail won't be sustainable."
Of course nothing lasts for ever but any solution will be short lived indeed if the political influence of the financial industry is not dramatically reduced.
Many people invoke FDR in this crisis. But it's another Roosevelt that we need to look to and that's Teddy. If the financial robber barons aren't brought to heel then everything else that is done will be for naught.
Savings & Loan fiasco of 1980s
The S&L disaster of the 1980s involved many small and medium sized firms.
I'm not sure what that demonstrates, but it's worth keeping in mind.
Too big to fail? No.
Kevin,
Please read the Atlantic article Hokuto posted, it will give you a little edu about finance - you need it,-
X-x-q-C; I couldn't have said it better.
Ifaforo - I'm with you, we need a Teddy Roosevelt handling these banks.
Kevin - It's not limiting the size - your worry - or capping them - Kwak's worry but it's keeping them separated. You need to inform yourself better on how much each type of bank can leverage.
The small corner commercial banks you're worried about can do 10 to 1 and are LIMITED in the types of loans and credit they can extend.
These bail out banks and hedge funds that you are in love with, when they own a commercial bank too they can bet those funds and their unregulated investment / hedge and others, leveraging them 100 to 1 too and a bit more.
So if, as Ifaforo suggests, we bust these guys up, using X-x-q-C's regulations we can get this problem solved and Mr. Kwak's capping won't be a problem because if these banks are broken BACK UP and placed under these rules then the market really will be able to handle the "bigness" that you think we need and you won't need to worry about small banks over leveraging themselves - because if you would inform yourself you would know that your corner bank is not allowed to do that even now.
Just remember one thing Kevin - the bigger a business becomes - the bigger the chance of it becoming a monopoly.
Of course in a pure, non regulated market, that's what you will get.
Bitibank
I am coining this type of solution 'Bitibank'.
If there is a bubble in a huge market, all the banks are going to be piling into the same trade _anyway_ and they will all bust at approximately the same time. The run on banks will be universal. So I don't see why breaking them up will help this.
Look at HFs today. They are all small (only a couple over $15B) and everyone is pulling their money out, leading to deleveraging and illiqiuidity in markets they previously dominated. This is leading directly to problems with judging the solvency of many banks.
And unless we reign in
And unless we reign in overleverage and massive waves of credit expansion,
"Rein in," Kevin. Not "Reign in."
The New Deal regime, let us
The New Deal regime, let us remember, worked very well- longest period of financial stability in recent history. We should prefer historical experience over theory, so its' compartmentalization of finance by region and function should be the default, or starting, position. Its' great advantage is that it primarily relied on structure, not regulation per se; that is, you don't have to regulate so tightly if institutions can be allowed to fail. This is more 'American'- a 'free market' as a gov't construct, versus a regulated monopoly or utility, with the great potential for political corruption noted above.
A history lesson
It's worth remember why so much banking consolidation happened in the 1970s and 80s. The biggest driving force was the rise of institutional investing, which suddenly presented banks with something they'd never experienced before: clients who were bigger than them, and who could therefore beat them down on price, especially after the early-70s banking deregulation that allowed stock brokers to compete on price (before that, the price per trade was fixed, and bankers could compete on every basis EXCEPT price).
The response of the banking industry was to consolidate heavily, and then invest huge in information technology that would allow them to essential bet against their institutional investing counterparties using complicated mathematics backed by the latest computing technology. The need for more and more capital, both to invest in infrastructure and to use in betting against counterparties also explains why all the now-consolidated investment banks eventually went public.
If you were to break down Wall Street into a much of small and medium sized firms, the institutional investors would have them over a barrel again. Whether you think that would be a good thing or not is another matter, but what's certain is that the center of gravity on policymaking would shift from the banks back to the institutional investors.
Too Big To Fail?
We have made a short video on the general topic of "Too Big To Fail" as applied to AIG. We call it "Throw It In The Hole."
http://www.youtube.com/watch?v=MdcscygVx0w
Nationwide banks
Where is it written that banks must be nation wide?
I lived for decades, many of them overseas, using the facilities of a local bank. I never experienced any inconvenience at anytime, be it in Hong Kong, Honolulu, Houston or Helsinki.
Size is Relative
You say that we don’t need small & medium-sized banks, that one that’s already failed, Bear Sterns, was ¼ the size of Citibank. But that doesn’t persuade me. The size doesn’t matter UNTIL they fail, then the bigger they are the more harm their fall does.
Size - potential harm
thre are two things at play
thre are two things at play here,
1.central(anglo)banking
2.corporate monoculture
this mutual assured finacial destruction isn't doing it for me
.how did we get so far down this road without notice of anyone?central banking is the the first step.i highly recommend watching this video
called"money as debt"video.google.com/ videoplay?docid=-9050474362583451279&hl=en -
corporate monoculture cannot continue without a artificial means of survival.
its ill proportioned stature only makes them more vulnerable ,as opposed to being stronger ;something they have tried to boast in the past.
diversification saves us of the perils of a darwinistic existence.
too big to fail?dinosaurs.
too big to fail? the elm tree.too
big too fail?the bison.
it's out of balance.
they tell us to diversify our investments,but not our banks?
who wins here?
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