Arnold Kling  

Should Banks be kept Small?

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Tyler Cowen does not see much help in keeping banks small. I agree with Simon Johnson, who thinks that big banks are too powerful politically.

I think that the issue does pretty much boil down to political economy. Big banks are likely to be more powerful politically when they get in trouble. For small banks to be powerful politically when they get in trouble, a lot of them have to get in trouble at once. That can happen, of course, but it is more likely to result from an economy-wide shock than from idiosyncratic risk-taking. I don't think small banks are a perfect solution, but I think that big banks are going to wind up with the same quasi-public, quasi-private status as Fannie Mae.


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COMMENTS (7 to date)
Felix writes:

Wouldn't a lot of small banks exhibit "emergent behavior"? That is, is there any reason why they would not swarm - all do the same, silly thing now and then?

I ask this because it sure looks like such behavior already happened. If you remove Vegas, Phoenix, Miami, and most of California, where does that leave the latest US credit/housing bubble?

Antisthenes writes:

It seems to me that the housing bubble has more to do with Fan & Fred and the influence "big" banks had on these quasi-gov't institutions.

I think it comes back to the core issue of one's ability to lobby for gov't favor. A small bank in MA had Frank's ear as much as Countrywide had Dodd's. If politicians had principles they would not succumb so easily to lobbying.

Troy Camplin writes:

The FDIC is currently nationalizing small banks that are in trouble and selling them off to the larger banks, so it seems pretty clear what the federal government thinks about large vs. small banks.

The Cupboard Is Bare writes:

Regarding credit unions. Someone suggested to me that in this economic climate, membership in a credit union is preferable to that of being the client of a small bank.

Would someone be so good as to shed some light on this for me?

Thank you.

fundamentalist writes:

According to Mises, Hayek and Huerta de Soto, smaller banks in a free market require larger reserves and can expand credit less than can larger banks. That would be one reason to prefer them. But we don’t have a free market. The whole intent of the Fed was to increase the ability to expand credit, and reduce the required reserves, as if all of the banks were merely branches of a single national bank. In terms of political power, small banks would just form a trade association, as have doctors and trial lawyers, that would have the same power and money as the larger banks.

George Berger writes:

Arnold,

See the article by Nicholas Economides, R. Glenn Hubbard and Darius Palia, "Federal Deposit Insurance: Economic Efficiency or Politics?" in Regulation, v. 22:3, pp. 15-17. I quote from the first page of the article: "federal deposit insurance was instituted for the benefit of small banks, largely located in unit-banking states, at the expense of geographically well-diversified large banksthat pushed for less restrictive legislation." Apparently, small banks can also play the rent-seeking game too.

Doug writes:

I have a friend who was senior loan officer from a small bank, his bank was forced to give a percent of the loans to Fred and Fan, when it hit the fan they had to pay out 41 million to them or someone, now the Feds are going to shut them down because lack of liquidy. Their only hope is to have a big bank buy them. Their private stock dropped from 22 dollars a share to 5 and now they can not even get rid of it at 5. We have been lead to believe that it was all the fat cats getting greedy but the fed had a big part of it to begin with.

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