Inside Financial Services

Keep Big Banks Big

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Aaron Klein, of Brookings of all places, says breaking up the big banks is not a good idea:

[Breaking up the large banks] would run contrary to consumer preference as believe it or not, consumers have been choosing to go to large banks more and more since the financial crisis. This trend may very well be tied to economies of scale and scope that allow large banks to offer better, quicker and newer technology such as enhanced on-line and mobile banking, larger ATM networks, and a broader array of services. . . .

There are other important questions regarding how a world with no large U.S. banks but large foreign banks would work for large American companies such as 3M or General Mills who sell products all over the world and value being able to work with global banks. There are impacts on how America’s capital markets, which provide debt financing for everything from local school districts to state governments to IBM, would be able to serve their customers. Small increases in the cost of capital can slow economic growth and increase costs for state and local governments. [Emph. added.]

Klein’s right on all counts! He fails to mention, however, that the reason so many bank critics are pushing for a big-bank breakup in the first place—that a such a move would help forestall another financial crisis—is totally misguided. As Peter Wallison likes to remind, financial crises happen when credit goes bad on a massive scale. In 2008, the credit in question was mortgages, especially subprime mortgages. Too many borrowers in too many markets defaulted too often, and the result was a disaster. At the peak of the crisis, something like $700 billion in mortgage debt was delinquent, and even mortgages that were current were viewed with suspicion. So much bad paper was owned so widely on Wall Street that banks came to view the value of each others’ assets with suspicion and became reluctant to fund one another. Boom. The panic was on.

The point, though (and this is where big-bank critics get things so wrong), is that it wouldn’t have mattered whether that toxic $700 billion was held by a few large institutions or many, many smaller ones. Overnight funding would have frozen up in either case, and the panic would have unfolded just the way it did.

In the meantime, as I say, Klein is correct to point out that consumers increasingly prefer to do business with large banks rather than small ones, and that large banks are vital in serving the financial needs of large global U.S. companies.

Bank critics seem to have a fetish about breaking up the big banks. Their fetish is misguided.

What do you think? Let me know!

3 Responses to “Keep Big Banks Big”

  1. Avatar Anonymous

    Every crisis has to have a villain, misguided as that often is. Most consumers know little about the benefits of scale, and the innovation it spawns. But they sure know it tastes good. It’s understandable, and misguided. Try taking consumer debit and mobile Apps away, oddly it would be another reason to have poor customer service scores. Go figure!

    • Avatar Randall Grossman

      Well said.

      I have wondered as well what Secretary Geithner would have done if he was not able to call the CEOs of the ten largest banks into his office in Washington and tell them that they had to accept the TARP money on the terms he dictated — whether they needed it or not. The ten CEOs recognized their responsibility to help stop the panic and agreed, even though for many it was not a very good deal. And then, subsequently, those banks collectively absorbed hundreds of billions of dollars in losses without costing the FDIC a cent. If Geithner had had to deal instead with hundreds of banks, I suspect that the financial system would have collapsed before he gained consensus.

  2. Avatar Anonymous

    Another good example to use to make this argument is the S&L crisis which involved many smaller banks.

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