Tuesday, February 24, 2009

Why We Should Break Up The Big Banks

Last week there was a lot of speculation that the US government would privatize mega banks, Citigroup and Bank of America, but now it appears that they are going to be happy with large stakes in the banks. The government believes that nationalizing the banks would ultimately cause more harm than good, and would like to avoid that path. Simon Johnson has a different view, though, he believes that the best course of action is to nationalize the big banks causing us so much grief, and then sell them off again in smaller pieces. This would ultimately remove much of the political power these monsterous institutions have over the government and our economy as a whole. Mark Thoma from the Economist's View looks at Johnson's article and adds some thoughts of his own in his blog post below:

Simon Johnson:

Privatize The Banks Already, by Simon Johnson: ...In some important and not good ways, we have already nationalized the financial system.

There’s the direct ownership that the government received through TARP and the reupping with Citi, BoA and some others. These stakes are obviously not (yet) voting stock, but the taxpayer certainly has capital at considerable risk.

Then we have the lines of credit provided by the Federal Reserve which, without a doubt, were instrumental to the survival of almost all major banks during the fall - and arguably remain critical today. The taxpayer has further downside risk here.

And, most importantly perhaps, we have the expansion of the Fed’s balance... In effect, the Fed is becoming a commercial bank as well as a central bank.

The government is essentially taking over the role of intermediation - take funds in and lend them out - for the US economy. This is a form of nationalization, and it will lead to all the lobbying and politically directed credits we have seen in other nationalized financial systems; taking away this credit once the economy starts to recover will not be easy. We have state control of finance without, well, much control over banks or anything else - we can limit executive compensation (maybe) but we don’t get to appoint directors (or replace entire boards) and we have no say in who really runs anything. Responsibility without power sounds accurate. ...

How then do we really privatize? By exercising leadership: take over insolvent banks and immediately reprivatize them. ... The taxpayer retains a significant number of shares (or the option to buy common stock) as a way to ensure upside participation...

Above all, we need to encourage or, most likely, force the large insolvent banks to break up. Their political power needs to be broken, and the only way to do that is to pull apart their economic empires. It doesn’t have to be done immediately, but it needs to be a clearly stated goal and metric for the entire reprivatization process.

No argument here. If there are good reasons to have banks so large their failure could bring down the entire system, a situation that gives them quite a bit of political leverage, I haven't heard them. There are questions about whether having many small banks as opposed to a few big banks reduces systemic risk, and if not, whether having lots of small banks makes policy intervention to stabilize and clean up the system more difficult when problems do arise - having just a few banks might be easier. But breaking up the banks does reduce political and economic power and I see no reason not to make this "a clearly stated goal and metric for the entire reprivatization process."

This post can also be viewed on economistsview.typepad.com.

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