America is still spitting mad over the financial crisis that hit the country half a decade ago and that continues to hang over the U.S. economy. And in the last few months, there's been a new wave of calls to break up the "too big to fail" banks that were at the center of the crisis — and the beneficiaries of a massive wave of bailouts.
So, is splitting those banks up the answer? That debate is just getting going.
More and more lawmakers and regulators don't like the financial system that they see: banks with trillions of dollars in assets, sprawling global operations that may be too complex to manage, and an implicit guarantee that governments will not let these giants go under.
The move to change that has a growing list of powerful allies. This week, the British government proposed a law that would break up giant banks that fail to separate their riskier trading activities from basic banking services. As Ezra Klein catalogued Monday, the list of those opposed to designating banks as too big to fail includes veteran bank regulators, such as former FDIC president Sheila Bair, FDIC vice chairman Tom Hoenig and Dallas Federal Reserve president Richard Fisher. Two of the nation’s most powerful regulators, Federal Reserve governor Dan Tarullo and New York Fed president Bill Dudley, haven’t gone as far as calling for break-ups, but they've have inched in that direction.
But what is the counterargument? As the push to split up the banks gains steam, it is worth wrestling with what value the megabanks offer the world economy, and what costs might be attached to breaking them apart.
A new paper from Patrick Sims of Hamilton Place Strategies, a policy and communications firm led by Bush administration White House and Treasury official Tony Fratto, amounts to a case for the big banks. (Hamilton Place counts major banks and their trade associations among its clients).
The entire paper is worth reading, but here are some of the arguments that I believe have the most merit.
The first argument is also the simplest. This is a huge and complex global economy. With trillions of dollars in global trade and companies with hundreds of billions in assets, it takes giant banks with a global reach to supply them with the financial products they need to do business.
The paper dismisses research that suggests there are no real economies of scale in banking above $100 billion in assets. Sims argues that this does not take into account that the megabanks are doing many types of business that smaller banks don't do, which makes the comparisons moot. Big banks provide trade finance for companies doing business overseas, underwrite stock and bond offerings, sell products to let companies hedge against fluctuations in currencies, commodities and interest rates — all activities that enable the giant global companies to do their work. It is a lot easier for Caterpillar or Boeing to sell American-made construction equipment and airplanes overseas when they have banks with massive resources to draw from when they need it.
The counterargument from the too-big-to-fail opposition is that smaller, regional banks can work together to syndicate loans, each funding a portion of the loan. Sims presents data showing that in practice, loan syndication is still done heavily by the giant banks; the top 10 banks in the U.S. loan syndication market were all either U.S.-based or international megabanks. For example, the largest syndication of 2012, an $11 billion loan to energy company Kinder Morgan, included funding from 10 major global banks, including the four biggest U.S. banks and others from overseas that would also fit in the too-big-to-fail category.
If the U.S. government capped bank assets at $300 billion (JPMorgan is $2.3 trillion), the four largest banks would become 25 mid-sized banks; that would suggest a company looking for a loan like the one Kinder Morgan took out last year would either have to turn to foreign banks or deal with the hassle of coordinating with dozens of smaller American banks.
This is related to a second line of argument: That without huge, regulated banks, companies will turn to the unregulated “shadow banking” sector to meet their financial needs, such as by issuing commercial paper. The collapse of the shadow banking system was a crucial factor in the 2008 crisis, and the government ultimately backstopped large portions of it, as well. If a bank break-up sparked a vast expansion of shadow banking, it would make the financial system more vulnerable.
I find less persuasive Sims’s argument that we shouldn’t worry too much about concentration in the banking system because it’s not quite as severe in the United States as in other countries. One of the paper's tables notes that the largest U.S. bank, JPMorgan Chase, has assets that amount to 15 percent of U.S. GDP, where other countries have much larger ratios. Switzerland has two banks, Credit Suisse and UBS, that each has assets of an eye-popping 177 percent of Swiss GDP; Britain’s HSBC has assets of more than 100 percent of British GDP.
But that strikes me more as a sign that Switzerland and Britain have big problems, not that the United States has it right. The fact that we can more easily afford to bail out our banking system than some European nations can is not a good reason to leave in place a system that will require periodic federal bailouts.
As the too-big-to-fail debate heats up, these are the questions that proponents of breaking up the banks and the financial industry’s defenders need to wrestle with. What real value do megabanks create for the world? Do they need to be this huge to fulfill their roles? Can regulation be enough to tame their inherent risks, or do they need to be split up?
I don’t know the answers, but properly resolving them is one of the crucial challenges for creating an economic future with more prosperity and fewer crippling crises.