Arnold Kling  

Break Up the Banks

Not a Fable, Unfortunately... Cowen Contra Pacifism...

James Kwak writes,

There is no inconsistency between this proposal and Macey's general skepticism about regulation. What he is skeptical about is the government's ability to precisely engineer desired market outcomes. Instead, what he prefers is a simple rule that makes possible free market competition without the distorting effect of implicit government subsidies: "Our proposed approach does not require any restrictions on activities of banks or on the location of those activities of any kind. Our only restriction is on the size of financial institutions."

He is referring to this paper by Jonathan R. Macey and James P. Holdcroft, Jr. As you know, I take a similar view.

I think maybe I saw Macey at a conference put on by the Bruno Leoni Institute last summer. I could be wrong...

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COMMENTS (5 to date)
Alex writes:

I'm sure this has been suggested before, but how about setting the capital requirements percentage according to the size of the bank? This would peg back the size of banks. Say, 8% plus 0.25% times market share. Or 8% plus 0.1% per Billion of market value. This would hold down bank size without an arbitrary ceiling, and reduce risk on big banks without harming the small ones.

Alex writes:

Obviously time would be needed to phase this in (2 years?), but it would be up to the banks to choose between splitting up or increased capital, or a mix.

Philo writes:

How is systemic risk reduced by a limitation on bank size? If several small banks fail, the need for bail-out is the same as if a single large bank fails. You must be assuming that the near-simultaneous failure of several small banks is less likely than the failure of one large bank; why assume this?

Perhaps your point is that the catastrophic failure of one single section of a bank will drag the whole bank down, impeding the operations of the good sections of the bank. If these sections were split up into separate companies, the bad one could fail without disabling the good ones. That seems an indictment of our bankruptcy procedures, which should allow the good parts of a big bank to operate even if there is also a catastrophically bad part. But you don't mention bankruptcy law reform.

PrometheeFeu writes:

@Philo: The "need" for a bailout (if there is such a thing) is the same, that is true. However, it would be much harder to do a bailout with any sort of speed if you had a large number of smaller banking institutions. So you might see a situation where the feds want to bail out the banks but can't do it in any sort of a reasonable amount of time because it would take too long to organize the bailout. Also, because the banks are smaller they each have less lobbying capabilities. So they may not be able to convince the government to have a bailout.

I am actually somewhat unconvinced. I much prefer the idea of forcing banks to have a "living will" which would allow us to quickly push them through bankruptcy proceedings.

But ultimately none of that matters unless the government is willing to not throw our money at the bankers whenever they mess up.

Thomas Sewell writes:

Somehow I envision big "non-financial" holding companies owning lots of small "financial" companies.

Or the same group of holding companies owning lots of them.

Or... you get the idea. Unless you also prohibit any chain of cross-ownership (which kills investors like pension funds, etc...) and have heavy enforcement within and without our borders, somehow I doubt that regulators will "win" this, based on past history.

All it will cause is extra regulatory friction as everyone has to reorganize and file more reports for more financial companies.

But hey, that'll be good for big banks, so they'll expand even more as the higher cost of doing business drives out medium size banks...

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