We need to break up the banks, but not necessarily their size. We hear a lot of talk about banks being “too big to fail” and they somehow if we break up these banks into smaller ones, the problems of 2008 will be nevermore. We have come to accept that it is the sheer size of a few banks that is at fault. Well yes, and no.
There is nothing inherently wrong with a large bank and there are benefits to having large banks. Large banks have lots of money (or should) and that allows them to weather financial storms better than small banks with little money.
It’s not the size of the banks that caused the great recession; it was their interaction, their connections to each other. Once again, however, there is nothing inherently wrong with bank connections (called lines of intermediation) but where these lines exist and their transparency are at the heart of the problem, and must be resolved unless we wish to repeat 2008.
Economists use arcane terms to describe things and if you and I were economists, I would use those terms to describe the problems we face. But I am not an economist and I assume neither are you, so I will explain this by way of an analogy
Instead of banks, let’s talk of ships.
There is nothing inherently wrong with a large ship. In fact, if a large number of people needed to be transported across a large body of water, there is nothing better than a large ship. Of course, there is a danger, there is always a danger. We all recall the Titanic. Still that disaster was not a verdict that all ships need to be broken down to a smaller size. We learned that we need to make big ships safer.
But the problem is that what caused the great recession of 2008 was not an iceberg, not an isolated event. What cause the problem was the way the banks were connected.
Let’s go back to the ships.
Imagine that, for security, ships agreed to be connected to each other with ropes or chains so that if one was in peril the other could tow it. If, say, a small ship wanted to cross the Atlantic, it could rent the services of a larger ship and tie on for the voyage. The rope or chain would remain slack for the journey if there was no bad weather or mechanical failure on the small ship. If the seas got rough of if the engine failed on the small ship, it would still make it to port safely. If the large ship’s engine failed or worse yet, was sinking, the small ship could simply cut the connection.
But let’s take this one step further.
In the previous example, the large ship earns a fee from the small ship in return for providing security. However, as we saw, if the large ship had a problem, the small ship was of no use. Imagine then, that the captain of the large ship had a brilliant idea. He would sell the services of his ship to many small ships at the same time. If one or two of the small ships needed a tow, it would not be a problem. However if all of the small ships needed help at the same time, that would be a huge problem, but the odds of that were exceedingly small considering this: If the large ship should fail, it could use the combined power of all the small ships to get to port.
The benefits of this are many as both the large ships and the small ships can benefit. The lines of connection are clear. Each ship’s captain can see all the lines that connect them, and it all flows from the large ship to the smaller ones.
In banking, these lines are called lines of intermediation, or, the connection of lenders and borrowers.
Now let’s get back the ships.
Let’s imagine that the captain of one of the smaller ships has run into hard financial times and cannot pay the tie-in fee to the large ship, but he has come up with an even more brilliant idea. He sells lines off his ship to other ships, some smaller, and some even larger but he assures them that since he is tied to a large ship, he can cover them. Of course the captain of the large ship would not approve, but that’s easily remedied. The captain of the small ship simply sets his lines of connection to other ships below the water line, out of sight, virtually undetectable.
The captain of the small ship thinks he is brilliant and worse, thinks that he alone is this brilliant. What he does not know is that all the other ships captains had the same brilliant idea. In a short time, we have several massive fleets, armadas, flotillas, all with visible lineal lines of connection on the surface, but below, in the briny deep, we have an unimaginable web of lines, from ship to ships, from fleets to armadas, from flotillas and no one is fully aware of what is connected and what is not.
In the earlier case of one small ship tied to a larger one, if the large one was sinking, the smaller one could simply cut the line and save itself. However, in this new arrangement a ship that is beyond the horizon could sink and the captain of a ship thought to have no connection would be caught unaware, since his connection is below the waterline and his connection to the sinking ship was facilitated through a series of agreements that he was not aware of. It would not be until the ship beyond the horizon sank and began to take his ship down that this captain would be aware, and even then, with the connection being below the water line, a quick fix would be out of the question. And of course, this ship’s captain has made deals with other ships, and in short time, they will share his fate.
Back to the banks
It’s not the size of the banks or the lack of regulations at the heart of the problem, it’s the fact that lines of intermediation have been allowed to grow so long and complicated and non-linear that no amount of regulation can be effective because the faults are impossible to see until it’s too late. Further, there are too many institutions offering too many services and many of these services are, in fact, not looking after the best interests of their clients. (Ships captains selling services that they have no legitimate right in selling and selling them under false pretenses) Additionally, there is a lack of standards and penalties enforced upon individuals who now hide behind a culture of organizations. (Wealthy ships captains blaming the fleet or ship’s owners, getting off scot free, while their employers pay a small penalty)
We do not need to break up the banks that are too big to fail, we need to break up the connections that have allowed the banking business to get as big and underground as it has gotten.
I have to say, I don’t agree with the first part of the hypothesis of “There is nothing inherently wrong with a large bank and there are benefits to having large banks.”
Using your boat analogy, when you put the entire region into a single boat, and that boat sinks, you’re done. Game over. When you have dozens of boats, if one boat sinks, the other boats can pick up the survivors.
You also have the added benefit of competition between the boats. Some boats are going to figure out how to do things better because they want to attract more passengers. With one big boat, if you don’t like what they’re offering, your option is “you can choose not to make the journey”.
Another benefit is for workers. When you have dozens of boats, there are dozens of opportunities to be a captain, a first mate, etc. With one large boat, there is one opportunity to be captain, one opportunity to be first mate. Yes, those positions will likely pay a crapload more than the same position on dozens of smaller boats, but most people won’t have a shot at them. Likewise, with just one boat operator, if you want to work on a boat as a deckhand, you can expect very low pay and bad working conditions, because your only other option is to not work on a boat.
This is a problem facing our country – the size of our corporations, and the lack of competition in so many of our sectors. Our CEOs want to be part of the global elite, which means they have to be paid tens, even hundreds of millions per year. That is only possible when they are the CEO of a massive corporation, so they look to grow rapidly through mergers and acquisitions. 2015 was a record year for such activity.
The other angle to consider is that individual customers are not at all important to massive corporations. If you have an issue with a local bank, you may very well be able to get to speak to their CEO who can, at the very least, consider your problem and try to rectify it. Massive banks have a wall of bureaucracy. I have a vacant bank-owned property in my neighborhood that the neighbors are trying to get back online. I can’t “drop by” the bank to speak to someone because the branches are staffed with tellers and a manager who knows nothing of foreclosures. I spent weeks trying to get through to their foreclosure department because the only number I have available is a call-center number, and no one there knows what to do. Once I finally got through to the foreclosure department I was simply told “we’re not allowed to discuss that with you, sorry”. End of story.
The main argument made for this activity is “it increases efficiencies”. That is doublespeak for “it makes more employees redundant, allows us to not have to bother with competing, and allows us to not have to worry about our customers too much”.
Did I? Again, if we break up the banks but NOT the arcane and unseen connections between them, what have we “broken”?
Nowhere in my post did I advocate for the consolidation of all ships into one. Nowhere did I suggest that competition be eliminated. But that seems to be your main point of opposition to my post, an argument over something I have not said, do not advocate, and would never support. You know this line of attack is called, don’t you? I mention fleets, flotillas, armadas, small and large ships, with no recommendations to eliminate any or consolidate all.
Yes, we do need to deal with the growing consolidation of businesses in this country. Four airlines control 80% of all air travel in the USA. Six six corporations control 90% of the media. 70 Percent of U.S. Beer is Controlled By Two Companies That Want to Merge
But this is a separate problem, and not central to why the banks failed caused the Great Recession and why we will suffer through it again if all we do it look at the size and not the system.