Arnold Kling  

The Case Against Big Banks

Another Look at Higher Educati... Dick Rutan on Aeronautical Pro...

My National Review article is now online. I've been getting some love from leftwing blogs and some pushback from right-wing blogs.

A few points

1. I don't want to bring back the 1920's, or even the 1950's, with all of the restrictions on interstate banking and such. What I have in mind is splitting up the ten largest financial institutions into, say forty.

2. I do not think that the financial system will be magically stabilized by breaking up banks. There are plenty of things that could still go wrong.

3. The advantages of breaking up the largest banks would be subtle. One is that an individual bank would be less likely to see itself as too big to fail. A second possible advantage is that there would be more diversity of thinking within the financial system. One of the more disturbing aspects of the housing finance boom/bust was the sheer groupthink involved. As I have shown in my published writing on the financial crisis, the key financial industry executives and regulators all "knew" the same things, which turned out not to be true. Maybe if there had been forty major financial institutions instead of ten, they would not have all shared the same outlook. It is possible (by no means certain) that some independent thinking might have found its way into the financial community, and perhaps even the regulators would have been open to diverse points of view.

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COMMENTS (17 to date)
Conn Carroll writes:

I agree with the goal, but I am still missing the how.

SB7 writes:

I'm intrigued, but what's the mechanism for making sure the banks don't become re-amalgamated in the future, sort of like the way the Baby Bells have been fused back together?

Thomas Sewell writes:

There are things that big banks do for customers that small banks can't, because of economy of scale.

Compare the web site and online services of Bank of America to that of your local credit union. I love credit unions (I'm a member of two), but they just don't have the economies of scale to justify spending nearly as much on technological (and other) infrastructure costs like a big bank does.

In the wholesale banking space, there are literally hundreds of bank services that big banks offer, but small banks can't, mostly for the same reason. Wholesale customers want a bank that they can do all their financial business with.

U.S. large banks aren't even that big compared to some of the world powerhouses in other countries. I think you're missing the point. Banks 1/10th the size would have responded to the same incentives that large banks did, if put into the same situation.

Your described solution amounts to trying to regulate ourselves out of the problems caused by previous regulations. Surely you can see that's doomed to failure? You state that the problem is mixing politics and finance. Why do you see the solution to be mixing in some more politics?

Either the big financial instutitions currently have enough political power to defeat any attempt to break them up, or else your premise is false. It'd be a lot more practical to take small steps in removing regulations and regulatory bodies from inhibiting new banks and competition and then letting the competition turn the average bank size smaller, if that's what's best for the economy.

In short, I think the market knows more about optimum bank size then either of us do. Let's let that work for us.

Disclaimer: I do contract work for a very large U.S. Bank, although not one mentioned above.

Eli writes:

Arnold, I take your proposal seriously, but could we not accomplish much of the same thing by doing the exact opposite? If banks were bigger, they would be too big to save. And if they were more international, governments would be less inclined to bail them out because politicians wouldn't want to spend money helping out other countries. Also if banks were more international, they would be more diversified. So it seems to me that larger, more international banks would also be superior to the status quo.

floccina writes:

How about in addition we look at breaking up the Federal Reserve and treasury in a few competing agencies, ending their monopoly control on creating money and monopoly on creating currency? Isn't it very difficult for a monopoly or near monopoly to tell if their prices and quantities are correct in something as complex and money?

R. Richard Schweitzer writes:

What seems missing from your approach is an analysis (rather than conclusions) as to how the existing systems have come into being and taken the "size," shape and "penetration" they have at this point in our economic development. That is, we have come a long way from the "Banci" of Venice.

Is it reasonable to accept that the systems have evolved as responses to at least perceived needs (even if the perceptions have not always been accurate or forward looking).

Have those needs changed? have other needs preempted them?

Do you conclude that we have enough information now to proceed to "re-design" a set of systems that indicate one form of spontaneous order?

Colin k writes:

Eli: "If banks were bigger, they would be too big to save."

how has that worked for Iceland?

Les writes:

Instead of breaking up the 10 biggest banks, I wonder what would happen if we just:

a) Liquidated Fannie Mae and Freddie Mac;

b) Opened up bond ratings from the present 3 to all comers;

c) Publicly announced that no bank would ever again be bailed out, no matter how big it was.

Doc Merlin writes:

I have to agree with Les here.

Michael M writes:

If you want to do something about big banks, get rid of the flow of credit coming out of the Federal Reserve, from which they tend to benefit the most (especially the designated brokers the Fed uses to auction treasury securities). Of course, the other caveat here is that we would need to get rid of the Fed itself, so this might be a bit of a self-serving recommendation.

The close relationship the largest banks have with the Fed is really the source of their competitive advantage they have over their rivals, nothing else. Without that relationship, they would fall back to whatever size the market would mandate for them. The more prudent would, I imagine, retain something of their current size because they've proven themselves to be efficient money managers. The less prudent would either shrink drastically or simply go out of business.

The main problem is that this would be a painful adjustment in the short run. The best solution to this is to loosen entry requirements into the banking business so that one large bank's disappearance can quickly be adjusted for by the appearance of many newer, smaller banks.

In other words, we should be listening to Larry White and George Selgin on these issues.

ThomasL writes:


The problem is no one would ever believe (c).

Felix writes:

As Arnold alludes to in the article, the effect of big banks can be had without there being big banks. There can be flocking behavior. "Everybody" thinks such and such. So "everybody" acts the same. "Everybody" being, in this case, bankers.

It seems to me that the problem that Arnold's trying to address can only be solved if the banking environment is changed.

Take a simple case. You have a gob of companies that all sell widgets. The widget buyers are all pretty much the same. They all pretty much want the same kind of widget. In such a case, we can expect that there will be few - as in one - widget makers in the end. There is not a lot of reason for more than one widget maker to exist. There are economies of scale. Etc. etc.

Now change the widget makers' environment. Let there be a great variety in widget customers. Let there be great variety in how widgets are delivered to the customers. Etc. What happens? There is a variety of widget makers.

So, what is the banking environment? If it is artificially homogenized, artificially made consistent, then stop. Not only is making the banking environment artificially consistent a waste of time and, perhaps, only a benefit to incumbent banks, but it is the root cause of "too big to fail". And it applies to banks being really big or to a lot of little banks all acting like one big bank.

James A. Donald writes:

The cause of crony capitalism is in the government, not the banks, and therefore cannot be fixed by changing the banks.

The feds were in the bank's pocket, but the banks were also in the fed's pocket. In any area where the housing boom and bust reached extravagant heights, (Sunnyvale, California) it is clear that people of certain ethnicities got even easier money than other people, due to the fact that George Bush hoped to win over certain ethnicities, and make them middle class.

The banks wanted freedom from responsibility, but the feds also wanted them to lend irresponsibly.

Ryan Vann writes:

"Compare the web site and online services of Bank of America to that of your local credit union. I love credit unions (I'm a member of two), but they just don't have the economies of scale to justify spending nearly as much on technological (and other) infrastructure costs like a big bank does."

I completely disagree with this argument. My credit union, Pentagon Federal Credit Union, has one of the cleanest website I've encountered amongst financial institutions. Having worked there for a brief time, I can also say they were probably more technology intensive than most banks; they were using the data mining and focused marketing techniques Citi is famous for. Credit unions, generally are much more committed to limiting costs, in exchange for less expansion, than are your typical banks, and as such have to stress processes and tech over advertising and workforce.

Troy Camplin writes:

I agree that we need to do this -- the federal government created these monster banks, and they need to undo the damage they've done. At the same time, it cannot be done without real deregulation -- the kind that would prevent the reamalgamation of the banks.

Allan Walstad writes:

I'm with floccina, and further: all the same arguments apply to government itself. Perhaps split off most governmental functions from the feds and into the hands of, say, 50 governments, with the feds' responsibilities clearly restricted and delineated. But then we'd still need more regulation to prevent all the powers from migrating back to the feds. Good steps in that direction: restore the election of senators by state legislatures, with summary power of recall; eliminate the income tax.

Troy Camplin writes:

Why stop at the 50 states? Keep on going down to counties.

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