Hulk Smash Banks (With Special Fees and Capital Requirements)
It really does seem like if even Alan Greenspan is coming around to the view that we shouldn’t allow financial institutions to grow to such enormous sizes that we really shouldn’t allow financial institutions to grow to such enormous sizes. What’s a lot less clear to me is what you can actually do, in practical terms, moving forward. Now if only someone like Alan Greenspan had been voicing these concerns back in the 1990s it would have been easy enough for regulators (like, you know, Alan Greenspan) to deny regulatory approval to the kind of mergers that gave us the superbanks of today. But while regulators can prevent big firms from merging and becoming super-big, I’m pretty sure they can’t just order Bank of America to unmerge itself.
This, I think, is one of the main reasons you hear more about breaking banks up from people talking to newspapers than you do from policymakers. What, exactly, are Ben Bernanke and Tim Geithner supposed to do at this point?
Which is why, I think, the idea of enhanced capital ratios and special fees is actually a pretty good idea. Greenspan says “I don’t think merely raising the fees or capital on large institutions or taxing them is enough.” He thinks we need to actually break them up. But raising fees and capital requirements can be a way of doing this. The point would be to make the fees and requirements onerous enough that the managers of large financial institutions find it worthwhile to start finding ways to spin things off and shrink. That would produce the goal of smaller firms without having the Treasury Secretary personally step in and reorganize the commanding heights of the economy. The test is that if the fees are imposed and banks don’t start doing this, you need to come back and raise the fees. The fees need to be high enough to generate substantial fee-avoiding behavior, you can’t just say “well, we’ve got some extra revenue so it’s all good.”
33 Responses to “Hulk Smash Banks (With Special Fees and Capital Requirements)”
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October 16th, 2009 at 1:09 pm
“I’m pretty sure they can’t just order Bank of America to unmerge itself.”
Yes, they can. You just do it through the anti-trust regulations rather than specifically financial industry regulation. It’s true that, in practice, childish versions of Chicago school economics made antitrust regulation moot in the US since Reagan took office. But, once you remove the necessity to rely on Chicago school economics, antitrust regulation of big banks is perfectly possible under current laws (no new ones probably needed).
October 16th, 2009 at 1:12 pm
But while regulators can prevent big firms from merging and becoming super-big, I’m pretty sure they can’t just order Bank of America to unmerge itself.
Oh but they can.
In fact, they already did it once before. Can you say “Glass-Steagal Act?
October 16th, 2009 at 1:16 pm
But while regulators can prevent big firms from merging and becoming super-big, I’m pretty sure they can’t just order Bank of America to unmerge itself.
Ma Bell would disagree.
Admittedly, that was antitrust, but it demonstrates that a regulatory framework can be constructed necessitating the division of corporate entities that have grown dangerously large.
October 16th, 2009 at 1:19 pm
Reversing all the deregulatory changes made in the last 30 years would fix 90% of the problems.
But they need to add criminal penalties – something even FDR couldn’t get done.
October 16th, 2009 at 1:32 pm
But they need to add criminal penalties
Criminal penalties for what?
October 16th, 2009 at 1:33 pm
It ended up being profitable for shareholders of Standard Oil; I’d guess the same thing of Ma Bell shareholders. (And did the break up of Ma Bell help foster competition for what became the internets?)
I have some trees in my back yard; they’ve gotten too big, and shade the vegetable garden. Time to remove them; let some light in to the understory. Isn’t the free markets for banks the same?
October 16th, 2009 at 1:35 pm
“we shouldn’t allow financial institutions to grow to such enormous sizes that we really shouldn’t allow financial institutions to grow to such enormous sizes.”
Was this intended to read “…grow to such enormous sizes that we can’t allow them to fail” or something? That’s my guess.
October 16th, 2009 at 1:38 pm
Obviously you can do this legislatively, since in various ways it has been done before. I’m not sure you can do it under existing law.
October 16th, 2009 at 1:39 pm
Matt,
What “you can do moving forward” is to withdraw deposit insurance from institutions which have or which are part of a larger holding institution which has more than 3% or 4% or maybe even 5% of total nationwide deposits. Obviously this would have to be done over a period of time to avoid runs on the big banks, but with sufficient warning it could be done safely.
Without deposit insurance these behemoths will be denied their depository base and will have to demerge themselves.
This is the free-market approach to banking reform. Smaller institutions at this time have an inherently higher cost of capital because the big guys have an implicit guarantee that depositors will be protected regardless of the size of their accounts. By revoking that guarantee for all depositors — anything else is not a credible “threat” — their costs will automatically become higher because people with FDIC-eligible accounts will move their money to institutions that conform.
What are the costs of such an action?
Well, nationwide retailers like Kroger, Wal-Mart, and big box retailers might be inconvenienced, but Wal-Mart already owns its own bank to reduce its card processing costs, as does Kroger. The others will probably do the same. As long as the “bank” doesn’t take deposits from the public, it can certainly serve as a nationwide credit card processor.
Depositors who travel frequently would be mildly inconvenienced by increased “foreign” ATM fees, but credit unions have formed a nationwide consortium that provides free shared ATM’s and even free shared teller services among something like 14,000 credit unions. The resulting regional banks could do the same thing.
Regional banks are more prone to economic downturns because they don’t have the “well California is hurting but Texas is booming” backstop of national banks. However, neither do they have the ability to drag the entire nation into financial Armageddon.
It seems to me that on balance the advantages of having smaller, more regional banks outweighs the disadvantages, and this is one extremely effective way to get there without having the big banks game the system.
Is it possible that it would pass Congress? I think you might be surprised how many mid-western Republicans might just go for it. No, the “I hate anything that the Democrats propose” lunatics from down South wouldn’t, but there are lots of fairly populist/libertarian Republicans from the wind states.
October 16th, 2009 at 1:42 pm
I wonder if Greenspan thinks this of insurance companies like AIG or Anthem.
October 16th, 2009 at 1:48 pm
Without deposit insurance these behemoths will be denied their depository base and will have to demerge themselves.
Plenty of people put money in money market funds and the Treasury protection for those ended last month.
http://www.firstamericanfunds.com/cgi_faf_nsec/cfm/TreasuryGuaranteeProgram.pdf
October 16th, 2009 at 1:53 pm
Anandakos,
I’m not sure BofA or Citi moving from offering traditional FDIC insured accounts to offering uninsured money market accounts would be that big of a deal.
October 16th, 2009 at 1:55 pm
Criminal penalties for what?
For intentionally breaking the law, e.g. misrepresenting an assets value, stock-pooling, front-running, etc. In accord with normal criminal procedure. Such penalties were introduced but not enacted during the New Deal.
October 16th, 2009 at 2:05 pm
A few thoughts;
–This is a criticism of Bernanke and the bailouts as much as anything. Too big to fail wasn’t a problem until Bernanke demonstrated that some were too big to fail. So to a certain extent this doesn’t work as a criticism of Greenspan (it would only to the extent that Greenspan supports the bailouts).
–Bernanke and Geithner and Paulson not only believed in too big to fail, they also encouraged BofA to get bigger. When the deal for ML looked like it might fall apart, they threatened BofA.
–Matt’s fascination with indirect and opaque policy measures is a constant wonder. If we don’t want banks to be as big as they are, we should choose and level and require them to get under it. We could use fees and enhanced capital ratios to accomplish the goal, and that would be a good idea if we knew what the value of the implicit subsidy is. But I’m guessing we don’t know the value of the implicit subsidy, and that the measure of whether fees and capital ratios were working would be whether they were breaking up banks to the same extent that a direct policy would, not whether they were breaking up some banks. So why not choose a direct and transparent policy?
October 16th, 2009 at 2:11 pm
Why would anyone take what Greeny says at face value? Why would anyone care what he says in any case?
The gigantic banks and investment banks were and are a necessary and vital part of American hegemony. You couldn’t have one without the other. They are inseparable. They are about power. Power of and for the elites.
It would be as easy as pie to bring forth a much more widely distributed system if there was the slightest will to do so by our elites. There isn’t. They cannot even imagine such a system. The only way it can come about is if their system collapses and we wrest what’s left from their cold dead hands and start anew.
October 16th, 2009 at 2:20 pm
An honest summary of what’s really happening by Robert Reich:
FROM: http://www.salon.com/opinion/feature/2009/10/09/october/
“…But in every case, what should be the centerpieces of reform are being left out. Why? Congress is overwhelmed with corporate and Wall Street lobbyists (far too many of whom are former Democratic office holders)…. The public doesn’t know what’s going on because the national media would rather report on the sexual escapades of famous people or social trends or high finance …”
October 16th, 2009 at 2:25 pm
I don’t believe this solves the problem at all, though. Banks also know that if they all do the same bad thing, allowing another crash, everybody has to get bailed out. The problem, after all, wasn’t that one bank was performing a heterodox strategy, went long, lost big, but that the whole industry did this. So banks should still be able to stay safe through herd behavior.
I think a lot of direct regulation forms part of the answer, but let’s not get hubristic about regulators’ abilities to keep up with the “creative” financial instruments the financial industry continually invents. The whole speculation-crash-speculation-crash cycle is one of the few things that’s been consistent throughout the whole history of capitalism.
October 16th, 2009 at 2:38 pm
@JMO,
You’re certainly right about people putting money in money market instruments. But FDIC insured deposits are significantly larger than money funds. As of June 30, 2008, before the crisis extended the Federal guarantee to money funds, the total of FDIC insured deposits in “All Institutions” was $7,025,791,000,000 (seven and a quarter trillion dollars). The best figure I an find for total money market deposits shows “about $4 trillion” just before the September panic.
So insured deposits were about 75% greater than uninsured, so clearly there is a “market” for people who are willing to take a chance on losing their principal. However, remember that the reason they do that is to get higher interest income.
So the thrust of my plan remains true: while it may be that BofA, Citi, Chase, and Wells have a minority of their deposits in FDIC-conforming accounts, the number is not zero. One or the other of them has a branch in every supermarket in America, so they would not greet depriving them of those low-cost funds with cheers.
Would it cause them to de-merge? They will certainly bluster about predicting all sorts of financial catastrophe, to which I would reply, “Well, you guys certainly are the experts on financial catastrophe….”.
I think only changing the law will let us know for sure.
October 16th, 2009 at 2:45 pm
By the way, I’m not averse to also raising capital adequacy ratios and FDIC insurance rates for everyone so that when the next slump happens the Corporation is adequately funded.
October 16th, 2009 at 2:47 pm
Anandakos,
But, that $7 trillion dollar number includes accounts that are far above the 250k FDIC insurance limit.
Google’s payroll account at Wells Fargo may have $100 million dollars in it but only 250k is FDIC insured. When you’re talking about a commercial bank many commercial bank accounts have balances far in excess of the FDIC limit.
October 16th, 2009 at 2:48 pm
Obviously you can do this legislatively, since in various ways it has been done before. I’m not sure you can do it under existing law.
DTM: this is true, but not necessarily very easy to do. Upon what do you base the law? Total bank assets as a percentage of GDP? Market share? My point being, a bank would have to spend a lot of time and energy concentrating on, er, not growing too large — as it approached the relevant benchmarks. I think this might be counterproductive. Investors might be reluctant to fund the operations of an institution they had reason to believe might be chopped up a year or two down the road. If we were to have such a law, I would argue that the relevant authority be empowered with discretionary authority to break up excessively large institutions – while eschewing the use of firm benchmarks (in other words, keep ‘em guessing).
I think a more workable approach would be to make the capital requirements more rigorous the larger an institution grows. Literally make it more expensive, or more difficult to be profitable, as a firm grows in size.
And no, it probably won’t ever happen.
October 16th, 2009 at 2:54 pm
Increasing taxes I think would be a better idea than increasing capital requirements.
The problem with increasing capital requirements is that it doesn’t do much to reduce the risk of bank default. Suppose your capital requirements move from 10% to 20%. So banks get 20% capital. Their competitors have 20%, so if they had 30%, they’d be uncompetitive. So everyone has 20%. Then the economy crashes. Now everybody has 15% capital and they are all bankrupt. Even though they would have been fine under the old law.
Increasing capital requirements would make it harder for larger institutions to exist, but if they did, they would be just as risky. So best, in my opinion, is to just use tax policy to directly limit their size.
October 16th, 2009 at 2:55 pm
Wow. The locked doors and flammable insulation at the Station weren’t a problem, either, until the fire started.
Demonstrating something doesn’t bring it into existence. It must exist before it can be demonstrated.
October 16th, 2009 at 3:04 pm
Increasing capital requirements would make it harder for larger institutions to exist, but if they did, they would be just as risky.
mpowell: I don’t follow your illustration and I don’t see how you can say they’d be “just as risky.” Surely the fact that they’re required to maintain more capital means exactly the opposite, no? It means they’d be more likely to survive hard times.
October 16th, 2009 at 4:43 pm
The whole speculation-crash-speculation-crash cycle is one of the few things that’s been consistent throughout the whole history of capitalism.
Yes and no. It certainly is from a broad perspective, but we had a decent run there between the Great Depression/WWII and the Savings & Loan crisis without a lot of systemic issues.
Now everybody has 15% capital and they are all bankrupt.
I don’t get it. If they have 15% capital left, why are they bankrupt?
October 16th, 2009 at 6:29 pm
Congratulations, Matt. When an Ayn Rand lifer like Alan Greenspan sees the need to break up concentrated and reckless economic power as directly as possible, and you don’t, the toothlessness of our “liberal” A-list bloggers couldn’t be more effectively demonstrated. Kudos!
October 16th, 2009 at 8:41 pm
Scott (#26), I think Matt is still OK with the idea of the Federal Government ordering a bank broken down into manageable pieces.
However, recognizing that Federal officials may be too weak-kneed to react in a consistent way, he supports regulations that would encourage the banks to do it on their own. It’s the difference between mandating a catalytic converter, and mandating emissions.
October 16th, 2009 at 9:53 pm
If you’re looking for incentives to split up large institutions, try penalties that effect the compensation of executives, not that of shareholders. It is the executives that will decide to break things up and they won’t do it just to improve the returns to their shareholders.
October 16th, 2009 at 10:16 pm
I think this is another one of those posts on really big topics that Matt just hasn’t thought much about.
October 17th, 2009 at 8:55 am
This is a simple issue.
Size and complexity/connectivity in the institutions we stand behind impose on us a risk of having to pay out horrendous amounts in a crisis. We have to charge premiums (call them fees, taxes or what you will) sufficient to discourage this type of high risk behaviour. If we do not, there is an implicit subsidy to that behaviour; and it will occur, to our cost and sorrow.
The principle is easy and Matt is right.
The devil is in the detail: we do not know exactly what behaviour we need to discourage, nor to what extent. So we start with fees that are probably low and incomplete; and build on that in the light of experience until we have shrunk the systematic risk from size and complexity to dimensions that don’t look too frightening.
Matt is right about how to go about the job, too.
October 17th, 2009 at 10:05 am
There is one time when a Too Big To Fail bank can indeed “just be ordered to break up” – and that is when it is insolvent.
The post assumes that there is no double dip recession in the offing – and of course, there may not be, since business cycle turning points are intrinsically uncertain. OTOH, for the same reason, there also may be.
And if there is a double dip recession, there will be an acceleration of bank collapses and need for yet another round of bank bail outs.
This would be the time to do the bail outs right – bring the bank into receivership, set up a “new good bank” with the liabilities we wish to see protected for the continued benefit of “Main Street”, match them with sufficient sound assets, and then allow the balance still in the hands of the old bad, previously Too Big To Fail bank to go through bankruptcy proceedings.
October 18th, 2009 at 11:44 am
Worth remembering in this conversation:
United States v. AT&T
and
Judge Harold H. Greene
October 19th, 2009 at 11:33 am
[...] would be wise. So you’re left with the difficult task of prudential regulation and trying to shrink the largest players over time with special fees and higher capital [...]