Simon Johnson is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”
Top executives from global megabanks are usually very careful about how they defend both the continued existence, at current scale, of their organizations and the implicit subsidies they receive. They are willing to appear on television shows – and did so earlier this summer, pushing back against Sanford I. Weill, the former chief executive of Citigroup, after he said big banks should be broken up.
Perspectives from expert contributors.
Typically, however, since the financial crisis of 2008 the heavyweights of the banking industry have stayed relatively silent on the key issue of whether there should be a hard cap on bank size.
This pattern has shifted in recent weeks, with moves on at least three fronts.
William B. Harrison Jr., the former chairman of JPMorgan Chase, was the first to stick out his neck, with an Op-Ed published in The New York Times. The Financial Services Roundtable has circulated two related e-mails “Myth: Some U.S. banks are too big” and “Myth: Breaking up banks is the only way to deal with ‘Too Big To Fail’” (these links are to versions on the Web site of Partnership for a Secure Financial Future, a group that also includes the Consumer Bankers Association, the Mortgage Bankers Association and the Financial Services Institute).
Now Wayne Abernathy, executive vice president of the American Bankers Association, is weighing in – with a commentary on the American Banker Web site.
These views notwithstanding, mainstream Republican opinion is starting to shift against the megabanks, as former Treasury secretary Nicholas Brady makes clear in a strong opinion piece published in The Financial Times.
Mr. Brady was Treasury secretary under Presidents Ronald Reagan and George H.W. Bush, and to the best of my knowledge, no one has ever accused him of being any kind of leftist.
Yet Mr. Brady’s thinking in his Financial Times commentary is strikingly similar to the reasoning that motivated the Brown-Kaufman amendment (supported by 30 Democrats and three Republicans) in 2010, which would have put a hard cap on the size and leverage of our largest banks, i.e., how much an individual institution could borrow relative to the size of the economy. (See this analysis by Jeff Connaughton, who was chief of staff to Senator Ted Kaufman; Senator Sherrod Brown, Democrat of Ohio, is still pushing hard on this same approach.)
Mr. Brady also stresses that we should make our regulations simpler, not more complex. Senator Kaufman made the same point repeatedly – and capping leverage per bank (Mr. Brady’s preferred approach) would be one way to do this.
Mr. Brady is not alone on the Republican side of the political spectrum. A growing number of serious-minded politicians are starting to support the point made by Jon Huntsman, the former governor of Utah and a Republican presidential candidate in the recent primaries: global megabanks have become government-sponsored enterprises; their scale does not result from any kind of market process, but is rather the result of a vast state subsidy scheme.
As Paul Singer, a hedge fund manager and influential Republican donor, says of the big banks, “Private reward and public risk is not what conservatives should want.”
A second problem for the bankers is that their arguments defending big banks are very weak.
As I made clear in a point-by-point rebuttal of Mr. Harrison’s Op-Ed commentary, his defense of the big banks is not based on any evidence. He primarily makes assertions about economies of scale in banking, but no one can find such efficiency enhancements for banks with more than $100 billion in total assets – and our largest banks have balance sheets, properly measured, that approach $4 trillion.
Similarly, the Financial Services Roundtable e-mail on “Some U.S. banks are too big” is based on a non sequitur. It points out that United States trade has grown significantly since 1992, and it infers that, as a result, the size of our largest banks should also grow.
But the dynamism of the American economy and its international trade after World War II was not accompanied by striking increases in the size of individual banks, and our largest banks did not then increase relative to the size of the economy, in sharp contrast to what happened since the early 1990s.
In 1995, the largest six banks in the United States had combined assets of around 15 percent of gross domestic product; they are now over 60 percent of G.D.P., bigger than they were before the crisis of 2008.
The Financial Services Roundtable is right to point out that banks in some other Group of 7 countries are larger relative to those economies. But which of these countries would you really like to emulate today: France, Italy or Britain?
The Financial Services Roundtable also asserts, in its other e-mail, that the Dodd-Frank financial reform legislation and the Basel III new capital requirements have made the banking system safer. That may be true, although the evidence it presents is just about cyclical adjustment; after any big financial crisis, banks are careful about funding themselves with more equity (a synonym for capital in this context) and holding more liquid assets.
The structure of incentives in the industry hardly seems to have changed, as witnessed, for example, by the excessive risk-taking and consequent large trading losses at JPMorgan Chase recently.
We need a system with multiple fail-safes, and making the largest banks smaller and less leveraged would achieve precisely that goal.
Mr. Abernathy’s article takes a much more extreme position. He contends that banks are already unduly constrained – by Dodd-Frank and Basel III – and this is holding back economic growth.
Mr. Abernathy goes so far as to say that if the banks were to raise $60 billion in additional equity capital, this “holds back $600 billion of economic activity.” In other words, strengthening the equity funding of banking would cause an economic contraction on the order of 4 percent of G.D.P.
Such assertions are far-fetched, not based on any facts and have been completely discredited (see the work of Anat Admati and her colleagues on exactly this point). Mr. Abernathy was assistant secretary for financial institutions under George W. Bush. If he has any evidence to support his positions – a study, a working paper, a book? – he should put it on the table now.
To make such assertions without substantiation is irresponsible. (A document from a lobbying organization would not count for much, in my view, but let’s see if he has even that.)
The big banks and their friends should be afraid. Serious people on the right and on the left are reassessing if we really need our largest banks to be so large and so highly leveraged (i.e., with so much debt relative to their equity). The arguments in favor of keeping the global megabanks and allowing them to grow are very weak or nonexistent. The arguments in favor of further strengthening the equity funding for banks grow stronger – see the recent letter by Senators Sherrod Brown and David Vitter, which I wrote about recently.
The views of sensible people like Secretary Brady, Senator Kaufman, Governor Huntsman and Senator Brown are spreading across the political spectrum.