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No need to break banks up

“There is no real evidence that any fewer UK banks would have gone bust had this separation been in place. It was not proprietary trading that brought down HBOS, it was bad lending to commercial property. Northern Rock, Bradford and Bingley and the Dunfermline did not own investment banks. RBS was brought to its knees as a result of a multitude of bad lending decisions, the over-priced takeover of ABN Amro and vast holdings of dodgy “assets”; its collapse was not caused by a giant investment banking bet gone wrong. In the US, it is likely that Citigroup would have required a bailout even had it not owned an investment bank. Generally, the same is true of all of virtually all the recipients of Tarp funds.”

Allister Heath, arguing against the idea, floated the other day by the Bank of England governor, that governments should force banks to split off their supposedly high-risk investment banking arms.

Of course, with the “too big to fail” doctrine now more or less entrenched, the danger is that politicians will feel – with some justification, arguably – that they do not want taxpayers to be held to ransom by the threat of having to bail out huge firms, so the “solution” is to prevent banks being so big in the first place. My own preference is that all state-backed deposit protection should be abolished, so that any bank operating on a fractional reserve basis would have to take its chances in a free market, with the only deposit protection coming from private insurance. But in the current policymaking environment, that does not appear very likely or politically palatable. But sooner or later, the idea of taxpayers’ underwriting the losses of FRB banks has to be confronted.

16 comments to No need to break banks up

  • Laird

    In a truly free banking market I would agree with you that banks (and any other companies, for that matter) should be as big as the market permits. However, as you noted, the problem (in the US, anyway) is the “too big to fail” doctrine. There is empirical evidence that this amounts to a governmental subsidy for such institutions, worth perhaps as much as 50 basis points. Furthermore, it creates a significant moral hazard, because to such banks there is no downside to making risky loans: if things go really bad the government will always bail you out. (That doesn’t help the shareholders, of course, but they are far down on the list of concerns for the entrenched “professional” management of such banks, and of course aren’t even on the regulators’ list.)

    In my opinion, “too big to fail” means “too big to manage” and therefore “too big to permit to exist”. Such banks should be split apart into units which are small enough that their failure would not create any systemic risk. Citibank is the poster child for this. In the last 50 years the US government has bailed out that institution (or its predecessors) at least three times that I can recall. That’s three times too many. It is clearly unmanageable, and should be put out of our misery.

    I do agree with you about privatizing deposit insurance, for a number of reasons which I won’t go into here. But, as you indicated, that “ain’t gonna happen” any time soon.

  • Gareth

    If the State regulates banking to the extent the FSA did – basically positioning the FSA between the banks and the free market by acting as the ultimate arbiter of what is and isn’t allowed (even if it didn’t understand what was being done) – it is honour bound to step in if actions distorted by the prescence and interference of the FSA go bad. Things like depositor protection, hefty and onerous (except for Northern Rock) compliance etc.

    Had the light touch regulation actually been light touch banks might have been more cautious. As it turned out it was just as with so much else – reality is the opposite of what the Government says. Combined with a degree of groupthink or arms race mentality over funny financial products that didn’t do what the quants reckoned they did our banks had a green light to lend irresponsibly.

    The big problem is of course, the State doesn’t, didn’t and would never be the one paying for it all.

  • While I agree splitting retail and commercial banking doesn’t make sense, it would be a good idea IMO to have a lot more, smaller davids in the field rather than a handful of goliaths that are too big to fail

  • ScotsToryB

    Surely the one thing that will bring home to the non-financially literate is pointing out again and again and again is that if a FRB lends you money and you default thay only need to recoup their initial fraction plus costs to remain in equilibrium. Anything else they recoup is profit.

    I keep reading here and in other places about the intricacies of the system, the dangers to the system, moral hazard, casino banking versus vanilla banking, the overwhelming danger to society of allowing banks to operate as they wish, the overweening danger to society of not allowing banks to operate as they would given open markets, the dysfunction caused by too big banks(cannot be allowed to fail banks)&tc.

    Howzabout peeps, one politician puts its head above the parapet and says ‘from the 1st October 2010 we will recuse FRB and move to a Government backed and therefore backed by the sovereign will of the people, system’.

    Buy a house and pay the mortgage back to us sovereign at, say an agreed rate of 5% over the lifetime of the mortgage, for everyone, for the foreseeable.

    Credit cards will only be allowed to charge, say 7% of the monies lent, no other charges. lend £100 get back £107 as agreed by us sovereign(discuss the %age as you will, it’s the necessary profitability to maintain the company that is important: it may be 7, 15 or 2%.).

    This will of course, shut out the international bankers lending to government and as a happy side effect remove their detrimental influence, remove the detrimental influence they allow to governments to overspend and borrow and may, just may bring some pragmatism to the system. It would mean less profits all round but less profits is not a bad thing in itself(as long as companies still make profits).

    I agree, FRB are the poison in the system but did not the last guy who proposed and as far as I know, started producing a silver backed dollar, pay for his impudence with his life?


  • Laird

    Wrong direction, STB. You’re proposing to have the government completely take over all lending functions. That makes absolutely no sense, on many levels (far to many to discuss in detail here). The solution is to get government entirely out of the lending function.

    What it should do is explicitly state (by statute at a minimum, and preferably via Consitutional amendment) that under no curcumstances will a bank ever again be “bailed out” for its improvident lending practices. Furthermore, no bank will be permitted to expand beyond a specified size otherwise than via organic growth (i.e., no mergers or other acquisitions will be permitted for such institutions), and any bank currently larger than a specified size (or some other clear definition of when it poses a “systemic risk”) has two years to divest itself of business units or financial assets so that it gets down below the target size. Failure to do so would mean seizure by the Federal Reserve and a forced sale of assets.

    What we need is many smaller banks, not a few goliaths, as was already said by Andy Janes.

  • Obviously Mr. Heath thinks, with reference to Citi, that all bailouts are equal, regardless of magnitude. This is not true. Less bailout, which would have been the case had the problem been only dodgy mortgages, is better than more.

    Since he brought it up, it should be noted the only bank of the three that participated in the ABN-Amro purchase that is left standing fully intact, Santander, is also the only one that did not participate in the structured garbage bubble.

    We can come up with better than this, can’t we?

  • Paul Marks

    One intervention leads to another.

    Once one has accepted the “too big to be allowed to fail” (“systemic risk”) stuff – then this stuff naturally follows.

    One does not have to be an economist or to have any experience of banking to know that all this talk is nonsense – and evil nonsense.

    Even an “alcoholic who is not drinking today” Glenn Beck, can understand it.

    “Do not bail them out – let them go even if they do take everything down with them. For if we hold to our principles we can rebuild the economy, if not in our time then at least for our children – but if we lose our honor we lose everything and hand over only putrid corruption to our children”.

    Sadly on hearing such words as “honor” such “economists” as Paul Krugman would smile (although the eyes would not smile – the eyes of a “Progressive” rarely do) and sneer at a “moral theory of the business cycle”.

  • cjf

    As long as individuals can hide behind the protection of institutions, nothing will change for the better, much will worsen.

    Speaking of “government”, “corporations” and unincorporated business (organized crime) as totally separate institutions is unrealistic. The cross-pollenization of personnel is too common, especially at the top. Being in one is almost a requirement for being in the other.

    The inter-locking directorates of incorporated, unincorporated and regulatory(government) are known.

    At higher levels, organizations protect individuals.
    At lower levels, organizations trump individuals.

  • Perhaps the various banks should jointly form a new institution, the “National Bank of Dodgy Deals”, and push all their dodgy assets that were acquired as a result of government pressure to acquire them into it. The government would then be only bailing one bank out, while at the same time, explaining to the taxpayers how these deals came to this pass in the first place.

  • It certainly seems pretty clear that in the US the straight investment banks have had a much worse time than combined investment banking and depository institutions. I.e., you can’t blame this on the repeal of Glass-Steagall.

  • And, per Gary B. Gorton, I hope the exact opposite happens–that we extend government guarantee of deposits to the wholesale market.

  • Laird

    Umm, point of clarification: my “agreed” was in reference to the first of vimothy’s posts (the one about Glass-Steagall), not his second one. He snuck in that second one before mine appeared.

  • Wolfie

    The State is “too big to fail” and must be broken up pronto.

  • Paul Marks

    There is no such thing as “too big to fail” – and yes that includes Fannie Mae and Freddie Mac (both government creations – and ones that acted under the “influence” of Congressman Barney Frank and Senators Chris Dodd and Barack Obama) and AIG (which was bailed out so that it could pay off the politically connected Goldman Sachs).

    It also includes the U.S. Treasury (and if anyone thinks the U.S. government is not going to de facto default on its obligations, most likely by continuing to moneterize the debt, then I have a nice bridge to sell you).

    As for the historic myth that “banks being allowed to do investment and retail banking caused the Great Depression”, it is B.S.

    The credit bubble money supply expansion of the late 1920’s (that of Ben Strong of the New York Fed) burst in 1929 – that would have caused a 1921 style mess. However, it was the reaction of Herbert “The Forgotten Progressive” Hoover to the crash ([particular his efforts to keep up wages and prices) that turned the crash into the Great Depression – and, of course, FDR (who had campaigned on cutting government spending) expanded Hoover’s absurd schemes once he was in the Whitehouse.

    As for Glass-Steagal – it was nothing to with “preventing another Great Depression”. It was a de facto “Bill of Attainder” against the Morgans (whose bank was the leading bank doing both retail and investment business).

    The Morgans were long time rivals of the Harriamans and the Rockefellers (John D. specifically) and had even, many years before, helped J.J. Hill keep control of his railroad when the Harriamans and John D. Rockefeller tried to break him (by the way the Union Pacific first tried bullets and bombs to break J.J. Hill before the Harriamans, having lost, went crying to John D. for help in a stock market bid to break Hill). And the new people in power spotted a way of hitting the rivals of their friends (using the Great Depression as a excuse), it was as sick as that.

    Of course Murry Rothbard was fond of pointing out that the Morgans had supported the creation of the Federal Reserve and so on – i.e. that they supported the creation of the very unconstitutional mega government that turned on them. But “two wrongs do not make a right” and NO a place not being a free market does not justify moving even further away from freedom.

    Bottom line is as follows.

    The economics of the statists is wrong.

    Their history is wrong as well (wrong, in part, because their economics is wrong – and one needs to understand economics before one can understand economic history).

    And the politics of the statists is wrong (because their economics and history is wrong).

    And the moral philosophy of the statists is wrong – not because their economics, history and politics are wrong (although they are). No, the moral position of the statists is wrong because they are shits.

    By the way this means that anyone who lends the government money (for example by buying T. Bills), or lets the government know about their real assets (such as that they own gold), or trusts government to look after them in the old age (farewell Medicare Advantage – you will have a lot of company in the grave yard soon) is a fool.