September 22, 2023

Economix Blog: Simon Johnson: Big Banks Have a Big Problem


Simon Johnson, former chief economist of the International Monetary Fund, 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.”

The largest banks in the United States face a serious political problem. There has been an outbreak of clear thinking among officials and politicians who increasingly agree that too-big-to-fail is not a good arrangement for the financial sector.

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Six banks face the prospect of meaningful constraints on their size: JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs and Morgan Stanley. They are fighting back with lobbying dollars in the usual fashion – but in the last electoral cycle they went heavily for Mitt Romney (not elected) and against Elizabeth Warren and Sherrod Brown for the Senate (both elected), so this element of their strategy is hardly prospering.

What the megabanks really need are some arguments that make sense. There are three positions that attract them: the Old Wall Street View, the New View and the New New View. But none of these holds water; the intellectual case for global megabanks at their current scale is crumbling.

The Old Wall Street view is that there is nothing to see – big banks know what they are doing and pose no threat to the economy. This position was in complete ascendancy before 2007 but is seldom heard today. In part, of course, the financial crisis made this view seem more than a little hard to defend.

And any attempt to resurrect this position was completely sunk by the “London Whale” losses suffered by JPMorgan Chase last year. We’ll learn more in the hearing on Friday called by Senator Carl Levin of Michigan, although the chief executive, Jamie Dimon, was not asked to testify. Senator Levin’s Permanent Subcommittee on Investigations is also expected to issue a report.

All these details about the London Whale will reinforce the view that even one of our supposedly great risk managers, Mr. Dimon, can lose control of what is happening in his business – on a scale that can matter for overall profits and, potentially, for the economy.

The largest banks have become too complex to manage. And when they fail, the consequences are huge for all of us. This point is completely nailed by Anat Admati and Martin Hellwig’s new book, “The Bankers’ New Clothes.”

The New Wall Street view is that there is no too-big-to-fail subsidy. Or perhaps there is a subsidy but no one can measure it. Or perhaps someone can measure it, but not the people who have done so. If the first view ended in tragedy – the crisis and huge job losses of 2008 – this New View is simple comedy.

My colleagues at Bloomberg View have written a series of devastating editorials explaining for a broad audience the nature and likely scale of subsidies that very large banks receive. You should read the series, starting with the latest contribution this week, which includes useful links to previous salvos on both sides.

The reaction of the industry is running roughly parallel to how church officials originally responded to Galileo’s work. No doubt the bankers in question would like to compel Bloomberg View to renounce its opinions.

Fortunately, we have come a long way since 1633.

And the banks’ lobbyists are making an uncharacteristic mistake by digging in with this extreme and indefensible view. Ask people in the credit markets if they think lenders to the biggest banks have some degree of downside protection afforded by the government (including the Federal Reserve). I have never heard any reasonable investor deny this reality in private.

The big banks are well down the road to acknowledging that there may be a subsidy and the question is how to measure it – and how to assess all the available evidence.

All data are complex. The Federal Reserve changes monetary policy on the basis of numbers that are hard to know precisely. What exactly is “core inflation” or the “natural rate of unemployment” at this moment?

And whenever people try to bedazzle you with econometrics, go back to the simple numbers and see a powerful story: megabanks have a funding advantage, if you think about it properly and compare apples to apples. See, for example, this column by David Reilly in The Wall Street Journal this week. (Mr. Reilly endorses a position similar to one I have advanced with Sheila Bair and other colleagues.)

The New New Wall Street view is that too-big-to-fail exists but that Dodd-Frank will bring it under control. This argument remains the best hope for global megabanks, but even this perspective is now under severe pressure.

This position has some powerful adherents, including Ben Bernanke, chairman of the Federal Reserve, and Jerome Powell, a member of its Board of Governors. (I wrote about Mr. Powell’s views in this space last week and about Mr. Bernanke the week before).

The problem is that Mr. Bernanke clearly articulated, during the Dodd-Frank debate, that the big financial companies would be pressed to become smaller of their accord.

Three years later, there is no sign of actually happening.

And now come Richard Fisher and Harvey Rosenblum, knocking hard on the gates of Washington with an op-ed article in The Wall Street Journal on Monday, “How to Shrink the ‘Too-Big-to-Fail’ Banks.”

Mr. Fisher is a successful private-sector investor who now heads the Federal Reserve Bank of Dallas, where Mr. Rosenblum is also a senior official.

From the heart of the Federal Reserve System – and deeply steeped in private-sector experience – comes a clear statement that too-big-to-fail exists and Dodd-Frank did not end it.

Attorney General Eric Holder’s testimony to Congress last week also confirmed the latter point: some banks are so big that the Department of Justice is afraid to bring legal charges against them, for fear of how that would affect the economy. Senator Warren of Massachusetts continues to press this issue relentlessly and very effectively.

You should also listen to this Bloomberg radio interview with Arthur Levitt, who acknowledges “too big to jail” about two-thirds of the way through. Mr. Levitt, a former chairman of the Securities and Exchange Commission, is currently an adviser to Goldman Sachs, so I expect he’ll have to walk this statement back.

Most worrying for the big banks, Mr. Fisher is more broadly on the right of the political spectrum. On Friday, he will address the Conservative Political Action Conference. I’m not sure a senior Fed official has ever done this before.

Mr. Fisher is not only entirely correct. He is also on a completely convergent path with Senator Brown of Ohio. In fascinating new development on Wednesday, Bloomberg News reported more details on the Fisher-Rosenblum push for a hard size cap on big banks, which would force JPMorgan and Bank of America, for example, to become significantly smaller.

The executives who live well on subsidies at big banks should be very afraid.

The Fed cannot long resist the pressure to measure and assess too-big-to-fail subsidies. The Government Accountability Office is in the process of doing exactly this, at the request of Senators Brown and David Vitter, Republican of Louisiana. As Senator Vitter put it, “Despite the claims made by the paid cheerleaders of the megabanks, Too Big To Fail is alive and well, and the banks receive taxpayer subsidies.”

He went on to say: “Chairman Bernanke knows it, the market knows it, and the taxpayers know it,” adding that he thought the G.A.O. study would “get to the bottom of” the facts.

We’ll get a range of reasonable estimates. And they will all suggest the continuing presence of subsidies for financial companies that are perceived as too big to fail.

And then Mr. Fisher, Senator Brown and other sensible people can help us move toward policies that will impose binding size constraints on our largest financial institutions.

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