BANKS aren’t always popular even in the best of times, but the anger of recent years is unprecedented. The anger, while understandable, has fueled the misguided idea that we should break up the nation’s largest banks.
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The argument is simple and sound-bite ready: In the years before the crisis, greedy bankers used their political muscle to grow from small, specialized banks into giant, all-purpose financial institutions. This transformation led to the financial crisis because banks became too big to manage and too big to fail. If we break them back up, we will eliminate the risk of future crises.
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The argument is simple and sound-bite ready: In the years before the crisis, greedy bankers used their political muscle to grow from small, specialized banks into giant, all-purpose financial institutions. This transformation led to the financial crisis because banks became too big to manage and too big to fail. If we break them back up, we will eliminate the risk of future crises.
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The problem is that every part of this argument is based on a fallacy.
The first fallacy is that the emergence of large, universal banks — combining commercial banking with investment banking — was an artificial or unnatural development. In 1990, there were 15,000 banks in the United States; this fragmented market meant that banks could not achieve economies of scale or easily serve clients on a national or global level.
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The consolidation that took place was driven by the market’s needs and represented an evolution toward greater efficiency in banking, just as companies like Amazon, Starbucks and Home Depot brought efficiency to retail. Even now, the American financial services industry is far less consolidated than its peers across most of the developed world.
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A second fallacy is that these large, universal institutions were primarily to blame for the financial crisis. As most serious observers acknowledge, a combination of bad lending and risk management by banks, poor regulation and ill-advised consumer behavior all played a role. None of the first institutions to fail during the crisis — Countrywide, Bear Stearns, IndyMac, Fannie Mae and Freddie Mac, Merrill Lynch, Lehman Brothers, the American International Group — were universal banks.
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A third fallacy is that large financial institutions have become too complex to manage. A company of any size needs robust management and controls to manage complexity. Remember that smaller financial institutions — look at MF Global, Bear Stearns, Knight Capital — have had their share of risk-management failures too.
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In fact, large global institutions have often proved more resilient than others because their diversified business model ensures that losses in one part of the enterprise can be cushioned by revenues in other parts. In some cases, complexity can be an antidote to risk, rather than a cause of it.
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Other criticisms of big banks that are often aired similarly don’t stand up to scrutiny. Commentators point to the inordinate influence large banks have on the political process. They fear that regulators are cowed by a large bank’s position and power. These critics seem to believe that regulators are incapable of making independent judgments. In the real world, this is just false. That said, it is perfectly appropriate and indeed necessary for regulators and politicians to engage with experts and industry practitioners to learn more about the issues. Regulators are not cowed, but they generally do need more expertise and better collaboration with one another to carry out their responsibilities successfully.
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Another criticism I often hear is that large banks receive huge, implicit subsidies from the government and can borrow more cheaply because they are seen as “too big to fail.” But the facts don’t bear this out. An AA-rated bank deemed too big to fail by pundits cannot borrow any more cheaply than an AA-rated industrial company. One can see it every day in their bond spreads.
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Finally, some critics have called for a revival of the Glass-Steagall Act (which separated commercial and investment banking) and a tougher version of the Volcker Rule (which would bar banks from using their money to make bets in their own trading account), without, it seems, having read either. The Glass-Steagall Act (repealed in 1999) prohibited commercial banks from underwriting debt and equity issues, a very safe activity; it did not prohibit banks from trading, engaging in derivatives, leveraging themselves or making bad loans. And while I agree with the spirit of the Volcker Rule, banks need to make markets for their customers and should be allowed to hedge their risks, as long as the hedging activity is specific to those risks.
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Large banks invest billions of dollars to deliver the products and services consumers want — investments that only a company that has achieved scale can make. Scale allows them to deliver, like big-box stores, more innovation, greater convenience and consistent, reliable service.
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Breaking up some big banks would hurt their customers, clients and the broader economy. It would actually inject new risks into the financial system. If today’s universal, multifunctional banks are forced back into being specialized lending institutions, they will need to find new ways to deliver returns to shareholders.
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That could easily lead to an increase in risky lending.
America’s largest businesses operate around the world and simply have to work with international banks. If they can’t work with a global bank based in America, then they will work with one based overseas. Losing that business to other countries would damage our national competitiveness, economic vitality, job creation and clients who want a choice of financial services. One of America’s great strengths is that we are home to the broadest, deepest and most efficient capital markets in the world. It’s a competitive advantage that we can’t afford to lose.
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