Volcker: Keep Banks Small Enough to Fail
I’d sort of forgotten that Paul Volcker had been tapped by Barack Obama to lead a special advisory panel on the financial crisis. But now I remember, and it seems a separate Volcker-led group has come up with recommendations for financial system reform:
The report offered 18 recommendations that would insert government regulators into the boardrooms of financial institutions as never before. The plan calls for vastly increased oversight of major banks, going as far as to recommend the end of an era of mega banks whose size makes their failure potentially catastrophic to the global financial system. To limit their size and scope, banks, the document states, should be prohibited from managing private-equity or hedge funds. And deposits should not be concentrated in the hands of too few banks.
“Keep them small, so that any failure won’t have systematic importance,” Volcker said at a news conference.
These seem like good ideas to me, but naturally not everyone agrees: “elements of the plan were already opposed Thursday by some in the financial industry, where some worry that the push for tighter government regulation may go too far.” I suppose the natural thing to wonder about that is what would going too far mean in this context? Would going too far lead to a major financial crisis requiring trillions of dollars in bailouts around the world? Double-digit unemployment? I mean, what are worried about?
UPDATE: Note, of course, that this is what I’ve been saying for a while. Elliot Spitzer, too.
35 Responses to “Volcker: Keep Banks Small Enough to Fail”
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January 16th, 2009 at 11:09 am
notice how Volcker’s lips still keep a place ready for that cigar!
January 16th, 2009 at 11:13 am
Size of bank is not related to whether they fail, as Volcker sees it. What he wants is that when they do fail, they don’t bring down the whole house of cards with them, as the big banks do.
And shouldn’t it be “systemic importance”, not “systematic”?
January 16th, 2009 at 11:18 am
It is not like banks need to be so big for efficiency reasons. I bet if you broke some of these banks up and eliminated some of the artificial incentives that favour large banks they would stay mid-sized and competitive. Also remember America has 10,000 banks so it is not hard to imagine the citibanks and banks of america being replaced by several successful mid-size banks.
See this story from 2006 for more:
January 16th, 2009 at 11:20 am
But ..but..but.. didn’t Bill Clinton and the Democrats join the Republicans in repealing Glass Steagall in 1999? How could a repeal that got 90 votes from our corrupt ..er..wise Senators and 386 votes from our corrupt..er..wise Representatives have been wrong?
http://en.wikipedia.org/wiki/Glass-Steagall_Act#Repeal_of_the_Act
Oh — I forgot. The repeal was also supported by the Financial industry lobbyists.
January 16th, 2009 at 11:25 am
Re DTM’s comment “I just don’t see how size was a major contributor to this particular crisis–basically, plenty of smaller banks have failed too and are being bailed out in one way or another”
—————–
The housing bubble losses are primarily concentrated in a few states: California, FLorida, etc. If we had kept Glass Steagall and kept banking confined within state boundaries, then the corruption/bubble would have been largely confined within a few states — and the rest of the country would have had the strength to mount a recovery effort. Instead, the 1999 repeal did the equivalent of letting 200 Hurricane Katrinas hit the entire country.
January 16th, 2009 at 11:28 am
Did the other Obama “advisors” . . . e.g., Rubin, Summers, Geither agree with Mr. Volcker?
How about the real estate agents on the Upper East Side, the Hamptons and Palm Beach? . . .
What about Kudlow, CNBC and the Wall Street Journal?
We need to hear from all those folks who have always put Wall Street ahead of the nation’s interest.
January 16th, 2009 at 11:31 am
Don Williams (@11:20) makes exactly the right point. I’d be interested in some analysis on the extent to which the 18 point Volker plan restores the elements of Glass-Steagal (1933) that were repealed by the Gramm-Leach-Bliley Act (1999).
January 16th, 2009 at 11:48 am
The idea of keeping entities from becoming too big to fail seems like a pretty natural extension of anti-trust law.
January 16th, 2009 at 11:51 am
What I love is Volker’s quotation of Adam Smith and relating 2009 to 1776 Scotland!
January 16th, 2009 at 11:57 am
Yeah, right. Like this will ever happen. Look where the lobbyists are and where the money goes. At least someone with some importance acknowledges this, but we’re still all screwed.
Watching this whole thing makes me really pessimistic.
January 16th, 2009 at 11:59 am
At this stage, Volcker is really calling for a breakup of megabanks and hydra-headed financial firms, isn’t he? Card check and reinstatement of the fairness doctrine would be easy by comparison.
January 16th, 2009 at 12:06 pm
Bailing out big banks has a small but powerful constituency. Indeed, I believe that bailing out the big banks has the perverse effect of reducing public support for government spending on, for example, infrastructure. After all, who is having good experiences with their banks. The same banks that go hat in hand to the government to rescue them from their own incompetence while providing little or no credit for long-term customers, rushing to foreclose mortgage loans rather than work with their borrowers, and, worst of all, putting five-day holds on customer deposits.
January 16th, 2009 at 12:16 pm
I just don’t see how size was a major contributor to this particular crisis–basically, plenty of smaller banks have failed too and are being bailed out in one way or another. So, I’m not at all convinced a somewhat less concentrated banking industry (and as industries go, it really isn’t that concentrated) would have led to a significantly lower need for bailouts.
Counterparty risk. When Lehman failed, for example, Lehman was holding positions with just about every financial institution in the world, so all of their Lehman-related positions took a hit and they were left holding a bunch of worthless or at least hard to value assets. This is not the case when Third National Bank of Peoria goes down.
The basic problem is that you can have simultaneous bank crises where many banks fail at once, and in that case you are still left having to bail out the many small banks as opposed to the few big banks.
Right, but want you want to avoid is having one bank (Citi, BoA) that is so big that when if it has a crisis all by itself, it takes down every other otherwise healthy bank with it.
January 16th, 2009 at 12:34 pm
Eliot Spitzer should definitely kept things small….
January 16th, 2009 at 1:40 pm
My point is more just that I think this is basically a secondary issue. Specifically, to prevent periodic banking crises requiring large bailouts, I think what you primarily need is direct, hands-on regulation of banks.
I should think greater regulation and keeping institution size smaller go hand in hand. A regulator entity is going to be less likely to be politically outgunned by ten medium-sized institutions than by one mega-institution. It’s the same reason management would rather deal with individual workers than with a union – banding together creates a more powerful product than the sum of the parts.
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