Has “Too Big to Fail” become “a policy enshrining crony capitalism” in the oft-quoted phrase, or does the argument against breaking up TBTF banks have merit? Do regulatory approaches to prevent systemic risk merely serve to institutionalize the TBTF concept? Let’s see who stands where in this collection of economic heavyweights.
THE BREAK ‘EM UP TEAM
Alan Greenspan, Former Federal Reserve chairman
When voices were clamoring to split up large banks last month, Alan Greenspan kicked the can down the road, so to speak, when he voiced concern over the implicit subsidy large banks get when taxpayers guarantee risky investment activities. In an address to the Council of Foreign Relations, Greenspan said (as quoted in Bloomberg):
“If they’re too big to fail, they’re too big,” Greenspan said. “In 1911 we broke up Standard Oil — so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do…
“If you don’t neutralize [the TBTF issue], you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society,” he said.
“Failure is an integral part, a necessary part of a market system,” he said. “If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.”
In the same speech, Greenspan also took issue with reforms consisting largely more/better regulation and higher capitalization requirement requirements, such as those floated by Barney Frank and the administration:
“I don’t think merely raising the fees or capital on large institutions or taxing them is enough,” Greenspan said. “I think they’ll absorb that, they’ll work with that, and it’s totally inefficient and they’ll still be using the savings.”
Similar sentiments were expressed by Mervyn King, head of the Bank of England, who states,
“The belief that appropriate regulation can ensure that speculative activities do not result in failures is a delusion.”
And from Simon Johnson, Professor of Economics at MIT professor and former IMF chief economist in an NPR interview:
“The basic problem is that the financial sector can hire the best, most talented people. It can pay them extraordinary amounts of money… They will always get ahead of the regulators.”
Johnson compares TBTF banks to an American oligarchy. He recommends capping bank size at $100 billion in assets and scaling up the FDIC to have the political power to intervene in banking activities a government-supervised process.
“We need to break them up for exactly the same reason that Rockefeller and the oil interests, standard oil, at the end of the 19th century, was too powerful, economically and politically. And it had to be broken up. And breaking it up was the right thing to do. That’s where we are with the banks today.”
Regarding the economies-of-scale argument for keeping banks big , Johnson says any benefits from large banks has to measured against the potential (read: huge) costs of failure:
“Particularly if you’re working across so many markets, you really want people with excellent local knowledge. So you can work with a network of financial institutions and you can hedge any kind of position you have through multiple contracts with smaller players. In fact, it’s probably not wise in this day and age to rely on one provider of financial services. You’re less likely to get a good price that way.”
More from Johnson in this Bill Moyers interview:
“Now, those bonuses are not the essence of the problem, but they are a symptom of an arrogance, and a feeling of invincibility, that tells you a lot about the culture of those organizations, and the attitudes of the people who lead them… [it’s] Go about your daily lives. Get the bonuses. Re-brand them as awards. But it really shows you the arrogance, and I think these people think that they’ve won. They think it’s over. They think it’s won. They think that we’re going to pay out ten or 20 percent of GDP to basically make them whole. It’s astonishing… Either you break the power or we’re stuck for a long time with this arrangement.
“Think of it like this, our taxpayer money is ensuring their bonuses… And we will be paying higher taxes, we and our children, will be paying higher taxes so those people could have those bonuses. That’s not fair. It’s not acceptable. It’s not even good economics…
“My intuition, from crises, from situations that have improved, the situations that got worse, my intuition is that this is going to get a lot worse. It’s going to cost us a lot more money. And we are going down a long, dark, blind alley.”
(Read more from Johnson’s blog here)
Paul Volcker, Former Fed Chair
Not so long ago, former Fed chair Paul Volcker advocated a return to the days of Glass-Steagall, which separated the banks investment and trading activities from traditional banking. Volcker said that under the Obama plan, financial institutions designated as TBTF banks “will be sheltered by access to a federal safety net” and the risk will remain, leading to future bailouts (at the same time confirming that “as a given” the government will continue to bail out banks in crisis).
Volcker clearly disagrees with extending any government assurances outside the banking system, to insurance companies and automakers:
“…the “safety net” should be limited clearly to commercial banks, while investment banks should be excluded.”
And although advocating splitting up the banks (but not arbitrarily), Greenspan does not see Glass-Steagall as the solution to TBTF, stating that: “No form of economic organization can fully contain bouts of destructive speculative euphoria.”
Readers note: Does that mean we should just fold up our tents and go home? Is it just me, or does that sound like guilt speaking?
(Color commentary from TPM: Had Greenspan not supported in 1999 Congress’s repeal of the Glass Steagall Act, which separated investment from commercial banking, we wouldn’t be in the soup we’re in to begin with. Summers and Geithner, along with Bob Rubin, while at Treasury in 1999, joined Greenspan in urging Congress to repeal Glass-Steagall. The four of them — Greenspan, Summers, Rubin and Geithner also refused to regulate derivatives, and pushed Congress to stop the Commodity Futures Trading Corporation from doing so. For more color commentary re: Volcker and Glass-Steagall from Charlie Gasparino, go here .)
And William K Black, Economics Professor and Senior Regulator during the S&L crisis, puts it this way:
The Treasury has fundamentally mischaracterized the nature of institutions it deems “too big to fail.” These institutions are not massive because greater size brings efficiency. They are massive because size brings market and political power. Their size makes them inefficient and dangerous.
Under the current regulatory system banks that are too big to fail pose a clear and present danger to the economy. They are not national assets. A bank that is too big to fail is too big to operate safely and too big to regulate. It poses a systemic risk. These banks are not “systemically important”, they are “systemically dangerous.” They are ticking time bombs – except that many of them have already exploded.
Professor Black contends that both the Bush Administration and the Obama Administration violated the Prompt Corrective Action law (see the Bill Moyers interview and rebuttal here.)
THE LET ‘EM GROW, LET’EM FAIL (BUT WITH APPROPRIATE CONTROLS SO THE ECONOMY DOESN’T COLLAPSE) TEAM
Ben Bernanke, current Fed Chairman
Current Federal Reserve chairman Ben Bernanke disagrees that TBTF banks should be split up or capped:
“We can address these issues in a way that doesn’t destroy the economic value of large, complex multifunction firms through other mechanisms,” Bernanke said.
For example, Bernanke cites that the Federal Reserve Bank of New York “has been leading a major joint initiative by the public and private sectors to improve arrangements for clearing and settling credit default swaps and other over-the-counter derivatives.”
But Bernanke did say that failing financial firms should be allowed to fail, provided the dissolution is orderly:
“We won’t have a real market-based financial system until it is safe to let a financial firm fail,” Bernanke said.
From a speech earlier this year, Bernanke spoke in favor of establishing a strong regulatory authority to address systemic risks. If an organization becomes “too big to fail,” Bernanke says, it encourages excessive risk-taking by the firm and “provides an artificial incentive for firms to grow, in order to be perceived as too big to fail.”
Bernanke goes a step further by stating that the Fed should have the supervisory authority for systemically important firms (like TBTF banks) but not systemic risk in general.
“We should leave open the possibility that if a supervisor decides that a particular firm does not have the managerial risk-management capacity to deal with a particular type of business — putting aside any capital requirements — there should be the ability to say you can’t do this activity,” Bernanke said.
Readers note: The Shadow Banking System lives on!
Sheila Bair, FDIC Chair
Although Sheila Bair, chairwoman of the F.D.I.C, recommends shrinking the “shadow banking system,” she does not advocate shrinking or breaking up the banks. Instead, she recommends extending regulatory controls to bank holding companies and other non-banking firms, such as insurers and hedge funds, as reported in the NYT:
“We need to end ‘too big to fail’ and this needs to be an overarching policy that applies to everyone,” Ms. Bair said, speaking to a meeting of the Institute of International Finance.
Financial firms subject to systemic-risk shutdown authority should likely also be required to publish “living wills” — details on how an orderly wind-down would play out — on their Web sites to provide clarity to shareholders and customers.
And by applying the resolution authority more broadly outside of normal regulated bank holding companies, it would help shrink the shadow banking system by discouraging regulatory arbitrage, under which financial firms shop for the most lenient supervisors.
“If you tighten regulation of the banks even more without dealing with the shadow sector you could make the problem even worse,” she said.
Tim Geithner, Treasury Secretary
Geithner would exempt retailers and other nonbank companies from oversight. He says:
“Regulators must be empowered with explicit authority to force major financial firms to reduce their size or restrict the scope of their activities when necessary to limit risk to the system. This is an important tool to deal with the risks posed by the largest, most interconnected financial firms.
“Regulators must be able to impose tougher requirements – most crucially, stronger capital rules and more stringent liquidity standards – which would reduce the probability that major financial firms experience financial distress, either through capital depletion or a run by creditors. This would provide strong incentive for these firms to shrink, simplify, and reduce their leverage.
“In addition, major firms must be subject to a prompt corrective action (PCA) regime and be required to prepare and regularly update what some have called “living wills,” which are plans for their rapid resolution in the event of distress. These plans would leave us better prepared to deal with a firm’s failure, and provide another incentive for firms to simplify their organizational structures and improve their risk management…
“Monitoring threats to financial stability will fall to the proposed Financial Services Oversight Council. The Council would have the duty and authority to identify any financial firms whose size, leverage, complexity, and interconnectedness pose a systemic threat and require those firms to submit to a system of heightened supervision and regulation.
The Federal Reserve would oversee individual major financial firms so that there is clear, inescapable, single-point accountability. The Fed already supervises all major U.S. commercial banking organizations on a firm-wide basis and all major investment banks as well.”
In testifying before the Joint Economic Committee of Congress last April, Nobel laureate Joseph Stiglitz offered a different view (quoted here):
“Before a crisis, every financial institution will claim that it does not pose systemic risk; in a crisis, almost all (and those that would be affected by a collapse) will make such claims.”
Paul Krugman, professor of Economics and International Affairs at Princeton University, says that TBTF is here to stay:
“I’m a big advocate of much strengthened financial regulation. One argument I don’t buy, however, is that we should try to shrink financial institutions down to the point where nobody is too big to fail. Basically, it’s just not possible.
“The point is that finance is deeply interconnected, so that even a moderately large player can take down the system if it implodes. Remember, it was Lehman — not Citi or B of A — that brought the world to the brink.
“So I think of the pursuit of a world in which everyone is small enough to fail as the pursuit of a golden age that never was. Regulate and supervise, then rescue if necessary; there’s no way to make this automatic.”
Many bankers look to JPMorgan Chase Chief Jamie Dimon, who says:
“As we have seen clearly over the last several years, financial institutions, including those not considered “too big,” can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company’s failure to another and to the broader economy. While the strategy of artificial limits may sound simple, it would undermine the goals of economic stability, job creation and consumer service that lawmakers are trying to promote.
“To understand the harm of artificially capping the size of financial institutions, consider that some of America’s largest companies, which employ millions of Americans, operate around the world. These global enterprises need financial-services partners in China, India, Brazil, South Africa and Russia: partners that can efficiently execute diverse and large-scale transactions; that offer the full range of products and services from loan underwriting and risk management to providing local lines of credit; that can process terabytes of financial data; that can provide financing in the billions.
Readers note: But isn’t that exactly the argument why large banks CANNOT be allowed to fail, specifically because of their size and interconnectedness (systemic risk)? Isn’t this a type of circular reasoning? He seems to be saying let us continue to take the same risks as before (leave in the systemic risk) but be comforted that we can now fail (because, as we have already seen, we cannot be allowed to fail because we are so interconnected, wink! wink!)
But in a speech back in June, Alan Greenspan dismissed the economies of scale arguments this way:
The perceived systemic impact of the failure of large financial institutions is the genesis of the “too big to fail” (TBTF) or “too big to liquidate quickly” problem. For years I have been concerned about the ever larger size of our financial institutions. A decade ago, I noted that “megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.” Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. I often wondered: had bankers discovered economies of scale that Fed research had missed? It is clear, in retrospect, that they had not.)
(Color commentary from the NYT: Several United States policy makers consider JPMorgan Chase’s chief executive, Jamie Dimon, as a potential successor to Treasury Secretary Timothy F. Geithner, The New York Post reported, citing sources. Mr. Dimon “would love to serve his country,” the newspaper quoted people familiar with his thinking as saying. )
And then, just yesterday from Morgan Stanley, this;
“In short, we think the demand for growth and access to credit will trump desire for unprofitable capital levels…
“Contrary to perceptions about [Sheila] Bair’s statements, we do not think there is any willingness to remove implicit support [for big banks]. In particular, we expect the discount window is unquestioned for banks, and TLGP [Temporary Liquidity Guarantee Program] type programs could exist in future crises. Regulators recognize the need for banks to make returns high enough to attract capital..;
“Even with appropriate leverage, the taxpayer has occasionally paid for the benefit of growth when financial shocks occurred. Repayment comes with subsequent growth.”
Readers note: Serfdom lives on!!
THE HINCHEY AMENDMENT AND SANDERS BILL
Just last week, Congressman Maurice Hinchey (D-NY) introduced the Too Big to Fail, Too Big to Exist Act, the House version of U.S. Senator Bernie Sanders’ bill S. 2746. His rationale (from Hinchey’s web site):
“Instead of trying to prevent future collapses of enormous banks or scrambling to come up with trillions of dollars in taxpayer money to bail them out, let’s avoid such a major risk by dismantling those massive firms now. Put simply, if a financial firm is considered too big to fail, then it is too big to exist and should be unwound quickly. As bad as this economic collapse has been, if we allow these goliaths to continue to exist then the entire economy could come crumbling to its knees.
Today, just four huge financial institutions (Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo) hold half the mortgages in America, issue nearly two-thirds of credit cards, and control about 40 percent of all bank deposits in the U.S. In addition, the face value of over the counter derivatives at commercial banks has grown to $290 trillion, 95 percent of which are held at just five financial institutions in the entire country (Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase, and Morgan Stanley).
“If an institution is too big to fail, it is too big to exist,” said Sanders, a member of the Senate Budget Committee. “No single financial institution should be so large that its failure would cause catastrophic risk to millions of American jobs or to our nation’s economic wellbeing. No single financial institution should have holdings so extensive that its failure could send the world economy into crisis. We need to break up these institutions because they have done just tremendous damage to our economy.”
And here is another interesting development in financial markets (from The Nation):
According to the Financial Times, Goldman Sachs plans to market a new financial instrument that will allow banks to reduce the capital required to hold risky assets on their balance sheets. Goldman calls this product “insurance” and expects to sell it to the banks with toxic portfolios, enabling them to shift the risk off their balance sheets.
Readers note: Can you say CDS?
This headline from yesterday’s LA Times seems to capture the mood du jour:
Proposal to allow breakup of huge banks gains momentum
Many are hoping the President takes a more aggressive stance than current reform proposals which leave in risk and taxpayers on the hook.
For more interesting reading and commentary, see these articles:
Czar Crossed: Stop blaming the pay czar, break the banks
Banking Group Warns Congress on Breakup Power
The Money Man’s Best Friend
Diana Farrell and the White House Theory of Bank Size
The Myth of Too Big to Fail
Debunking the “Too Big to Fail” Myth
Paul Volcker, Mervyn King, Glass Steagall, and the Real TBTF Problem
Citigroup is Well Run: Why the Treasury’s Plan Will Fail
US Rep Bernard Sanders and TBTF
Why Jamie Dimon Wants to Silence Paul Volcker
Breaking Up the Big Banks, and Why Congress Won’t Do It
The Forgotten Fed Chairman, Why Is Paul Volcker Being Silenced?
Could Wall Street Actually Lose in Congress?
Morgan Stanley Speaks: Against Relying On Capital RequirementsStocksFinancialBACCWFCJPMXLF
Considering the U.S. Equity Market has recovered roughly half of the losses from the crash, now is the perfect time to gauge sentiment for the year. Let’s see what some persuasive people are saying about 2010 …
We could not let pass the silly commentary last week in the Big Media regarding the fiscal situation of the Federal Housing Administration, the Federal Home Loan Banks and the other GSEs. The head of the FHA, Commissioner David Stevens, says that the agency is solvent and will have more than sufficient reserves to meet its obligations, primarily guarantees on 37 million first lien mortgages. We disagree.
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