Big Bank Breakup or Tea Party?

by Chidem Kurdas

We’ve been going back and forth on the economics of too-big-to-fail banks but paying less attention to the politics. The most recent ThinkMarkets broadside on banks is Jerry O’Driscoll’s post on the Federal Reserve Bank of Dallas annual report.

In part of the report, the Dallas Fed’s director of research Harvey Rosenblum argues that the new Dodd-Frank regulations are insufficient to deal with the threat posed by too-big-to-fail banks and therefore these need to be broken into smaller entities. He and the bank’s president, Richard Fisher, made a similar point in a Wall Street Journal column.  Some other Fed officials have espoused the position as well. 

Mr. Rosenblum offers an account of how the 2008 financial crisis came about, deftly weaving together various strands that together appear to have led to the catastrophe. Banks that “have grown larger in recent years because of artificial advantages, particularly the widespread belief that government will rescue the creditors of the biggest financial institutions” have a central role in this picture. In the crisis the government did bail out the main players, strengthening the belief.

Dodd-Frank was supposed to provide the alternative to bailouts, namely a way to liquidate insolvent large banks in an orderly fashion so as to minimize disruption in the financial system. Mr. Rosenblum suggests the new liquidation procedures may not be adequate in a major financial crisis if too many banks fail simultaneously, overwhelming the resolution fund financed by fees on banks.

More fundamentally, he questions the credibility of the Dodd-Frank commitment not to bail out failing financial businesses.  “Words on paper only go so far. What matters more is whether bankers and their creditors actually believe Dodd–Frank puts the government out of the financial bailout business,” he writes. If not, both groups may continue to take excessive risk, cause crises and get propped up with taxpayer money.

How can the government make a believable commitment in the light of past extensive bailouts? (And continuing bailouts of government-sponsored mortgage giants Fannie Mae and Freddie Mac.)

This is a political problem that requires a political solution. Obviously, what’s needed is a Tea Party government that is ideologically committed to not bailing out anybody or anything, whether bank, mortgage financer or automaker, big or small. More immediately, each candidate for public office can be asked to pledge to oppose bailouts and held to account if he or she violates the pledge.

Instead, the Federal Reserve’s neo-trustbusters advocate compulsory slimming down of big banks. Mr. Rosenblum acknowledges that this will be difficult and costly, and not only because the banks oppose such policy. Even if they meekly went under the knife, it is not clear how to do the procedure. But, he says, it is worth doing anyway so that this threat to the economy is removed.

Consider what it would involve. In effect, the government would take control of hundreds of billions of dollars worth of property and decide how to dispose of it. This would not only make a mockery of property rights but also create immense opportunities for corruption. Politicians and government bureaucrats would decide who will benefit from the breakup deals and who will lose. Interested parties can offer endless and subtle inducements to get the benefits.

Mr. Rosenblum complains of Dodd-Frank that “The law’s sheer length, breadth and complexity create an obstacle to transparency, which may deepen Main Street’s distrust of Washington and Wall Street…”  The breakup of banks can only further deepen that mistrust.

5 thoughts on “Big Bank Breakup or Tea Party?

  1. Regardless of one’s views on either antitrust generally, or the Dallas Fed proposal in particular, Chidem has seriously mis-stated how a breakup of a firm works. The government does not, as he asserts, “take control of hundreds of billions of dolars worth of property and decide how to dispose of it.”

    Fisher and Rosenblum describe their proposal as “restructuring” and that is not far from the mark. The banks would be forced to divest businesses and assets to other private entities. It would be done under court supervision.

    Chidem does not address the main point of the Dallas Fed critique, which is that government bailouts were “quasi nationalization” (amounting in their estimate to one-third of US banking assets). What did the taxpayer get in return? More debt. The restructuring is their alternative to more bailouts.

    Chidem’s calls for a government “ideolgically committed” to no bailouts. I don’t care what a government’s ideology, if Citibank is about to go under (some would say for the 4th time), there will be powerful forces for a government bailout.

    Look around the world. Governments bailout “huge banks.” No matter their ideology. That is the problem the Dallas Fed is addressing. If you don’t like the solution, you need to come up with a workable, alternative plan. Invoking the Tea Party’s name is not a plan.

  2. Jerry O’Driscoll–
    Re your main criticism–namely that I “seriously mis-stated how a breakup of a firm works. The government does not, … “take control” but rather “The banks would be forced to divest businesses and assets to other private entities.”

    I don’t see how the two descriptions would differ in reality. If you’re forcing assets to be sold, you in effect have taken control of them from the legal owners. The fact that the government does not intend to operate the business may suggest this is not full ownership, though even that could not be taken as granted, as government representatives do sit on boards. In any case, one major feature of ownership, the right to sell, would be taken over by the government.

    You could say that the FDIC does this anyway with failing commercial banks. But those are failing and a similar mechanism for large banks is in Dodd-Frank. You and the Dallas bank people are proposing something beyond that, for currently viable banks.

  3. Re “It would be done under court supervision.”
    Well, if you want to trust the courts, then why not let them deal with the banktruptcy of big banks? If the courts were capable of doing this in a reasonable way, there would be no problem to begin with.

  4. And what you steadfastly refuse to recognize, Chidem, is that the largest banks are already creatures of the state. When they get in trouble, their liabilities become taxpayer liabilities.

    They are “viable” because of their taxpayer backing. If the taxpayers decide to limit their exposure, they are not violating property rights of bank stockholders, but protecting their own property rights.

  5. As a taxpayer, I resent being given this liability — not something I wanted or volunteered for – and then being told to take bank shareholders’ property so as to protect myself. I should look for other means of protecting myself, because otherwise there will be no end to this kind of scheme.

    I grant you, as you put state it, it sounds like a powerful argument. But there is something fundamentally wrong. This is a government failure, a political problem. It crops up in a variety of ways, not just with big banks. After all, Chrysler was bailed out as well as GM– yet Chryster is not that big a company. The solution has to be political.

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