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Why We Must Break Up the Banks
Paul Krugman says it isn't necessary – but breaking up financial giants would at least give us hope that things can change
It's not often that I disagree with Paul Krugman, but there are occasions where at least one of us is wrong. And the treatment of too big to fail (TBTF) banks is one of them.
Krugman argued in a column last week that breaking up the TBTF banks is not a necessary part of financial reform. Krugman pointed to the example of Canada as a country with a well-regulated financial system. Canada did not experience a financial crisis in 2008 in spite of the fact that five big banks essentially account for the whole of the Canadian banking system. On the other side, Krugman noted that the collapse of large numbers of small banks can also create a crisis, pointing to the chain of bank collapses at the start of the Great Depression.
These are valid points, but to paraphrase Dorothy in the Wizard of Oz: "we're not in Canada anymore." While Canadian banking regulation appears to have been effective thus far (we may want to see how they cope with a yet to deflate housing bubble before pronouncing it a success), Canada is a very different country from the United States. In Canada, they have had universal Medicare for 40 years. As the first President Bush used to say, it is a kinder, gentler, country.
This matters for financial regulation, because there is a level of independence and integrity on the part of the regulators in Canada that does not exist in the United States. The line in Washington is that if you want to talk to someone from Goldman Sachs, call the treasury department.
The close connection between the industry and the regulators matters because regulation will always require judgment calls. It also matters because regulation means limiting bank profits. The regulations are by definition about preventing banks from carrying on lines of business that are profitable.
Going back to the last crisis, our regulators should have cracked down on the junk mortgages that were being issued by the millions to buy homes at bubble-inflated prices. But this would have meant clamping down on banks that were making huge profits issuing the loans. It also would have meant clamping down on the investment banks that were making huge profits packaging them into securities and selling these securities all over the world.
To take an even more extreme case, the recent analysis of the Lehman bankruptcy showed that New York Federal Reserve Bank helped to hide Lehman's insolvency for months. It accepted Lehman's junk as collateral for short-term loans. This was a direct violation of the Fed's charter, which only allows it to accept investment grade assets as collateral, a definition that clearly did not include Lehman's "Repo 105s".
In these cases, our regulators instead used their judgment to decide that everything was just fine and looked the other way. Remarkably, no regulator was fired for these astounding failures in judgment. In fact, there was probably not even a single regulator who missed a promotion.
In the United States it will always be easy for regulators to look the other way, even when the ultimate consequences prove to be disastrous. By contrast, cracking down on politically connected banks is difficult for regulators. The banks' executives will call their friends in the administration and Congress to complain about the crazy regulator who is trying to keep them from running their business.
And, you can be sure that the banks will have a story. They pay smart people lots of money to develop those stories. The banks' mouthpieces will make a conscientious regulator look like a crazed vigilante who just doesn't understand modern finance. Just ask Brooksley Born, the head of the Commodities Futures Trading Commission who was stopped in her effort to regulate credit default swaps back in 1998.
Krugman is right that breaking up the banks does not guarantee good regulation. In addition to his Great Depression example, we also have the savings and loan disaster of the 80s. The S&Ls were overwhelmingly small institutions with even the largest being far below any conceivable TBTF threshold.
However, a break-up of the big banks will at least give the country some hope that things can change. As it stands now, the big banks are back on their feet, and in some cases more profitable than ever, feasting on the now explicit government guarantee of support in the event of a crisis. By my calculations, this guarantee could be worth as much as $34bn a year, more than one-third of the gross cost of the healthcare bill.
There are many aspects of regulatory reform that involve technical issues that the public will not follow. If we have to say what is different the day after financial reform is passed, rules on leverage limits and exchange-traded derivatives will not mean much, especially if they are enforced by people who accept Repo 105s as investment grade collateral.
If we break up Citigroup, Goldman, JP Morgan and the other giants, then we will know that something has changed. This break-up, along with a financial transactions tax, will lead to a qualitatively different financial industry.
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29 Comments so far
Show AllDean Baker you are right... but we operate under the golden rule in the US--those with the gold rule.
Mr. Baker is incorrect. "Hope is for little kids and tooth fairies." J. Bageant. Mr. Baker should very well know that business naturally seeks efficiency in the maximization of profit. This means monopoly is the last stop in evolution of business. Since we've tried reform back in the 1930's and it didn't take why would we repeat the same actions i.e. Glass-Steagall. It bears repeating that the definition of insanity is repeating the same thing over and over and expecting a different outcome. I think Mr. Baker knows what must be done, but is afraid to say it out loud.
The oft-repeated, idiotic adage concerning insanity is obnoxious and patently wrong in the vast majority of situations. Statistical distributions demand that repeating the same action will produce a variety of outcomes. Anyone who uses a computer knows that performing the same action, such as rebooting a computer, may indeed produce other results. As a scientist, my entire livelihood depends upon this very attribute of nature. The universe, and its infinite subsets, are overwhelmingly non-deterministic.
Secondly, you can't claim that the implied reforms failed. It was the revoking of those reforms that produced the results to which you're referring. Glass-Steagall, as far as I know, worked as desired by those who enacted it.
Thank you. The banksters had their politician whores REVOKE the FDR reforms precisely because they DID work, & prevented them from their empire-building activities.
So you admit that Clinton and his team are corrupt and considering that they are most of Obama's admin casts a shadow of doubt on him. Yet you probably voted for him twice and would vote for him again if he ran. Repeating the same wrongheaded policy over and over will yield the same rotten result. GIGO. You have to look harder at the big picture. But i' m willing to bet your sweet bippies that you don't earn your keep by watching out for working people. Here's something to remember Republican's are corrupt and the Democrats just less so.
Yes. Either corrupt,or of the "cave-in" variety which leads to the same thing. R & D parties mean nothng. It's a "good cop/bad cop" scam. I've sworn off the two corporate parties & I'm tacking LEFT. I wish there was, AT THE LEAST, an FDR party.
Greens perhaps.
No I didn't vote Clinton. I used to be a libertarian (not really very political until 2000). I voted Ron Paul back when he ran as a libertarian (thank God that went nowhere). My 1st election that I could vote in, I voted McGovern. In 2000 I went back to my leftish roots & voted Nader (wish I had stuck with him). I voted D sucessively to stop the R insanity. I now see R & D will do us no good. Tacking Left 'til I hit solid ground. My fantasy is a leftward Constitution party (the C is NOT how right-wingers "interpret" it. The Preamble TELLS on them...end of story).
The constitution should be a living document, but right know it is locked up. The solution is democracy. Are we brave enough?
I have the courage of a cornered bunny rabbit, who can be be pretty effing brave (& desperate),when cornered by the fox.
Baker is wrong. It's not the banks that need to be broken up, per se, it's the private control of the central bank, the Fed, that needs to be broken up. The superstructure of the banking industry is just taking advantage of the core defects of the system - debt-based currency subject to interest - and leveraging it to their advantage. It is now a true protection racket situation, which is why the term "banksters" is so appropriate.
Take a look at Stephen Zarlenga's American Monetary Institute & their 32-page pamphlet on their monetary reform act. This will exactly answer your questions.
Also,Lincoln's Greenbacks are an example of a non-debt based (& actually the only Coinstitutional) currency. Read all about it at AMI.
Even if the big banks get broken up, wouldn't the Fed just have the power to put them back anyway? I was thinking that the Fed should be abolished and that people should consider joining credit unions and let the banks fail. I wouldn't leave out the idea of breaking the banks but I just can't trust the government to do it honestly without the possibility that government might make it easy for them to merge again. This nation is a lost soul and what's left to trust of this government other than for us to just beg them to leave everything alone?
There is no way around the fact that we MUST control our own gov't. No way around it. I rather enjoyed my apolitical life before W happened in 2000. I now see we can't afford that luxury. WE MUST be political & control our own gov't. It's the ONLY way we can possibly trust the gov't to do anything right. The non-existance of gov't is NOT an option. It's TOO USEFUL as a tool to not exist. The enemy will create one if it doesn't exist. And who's the enemy?...whoever is NOT We The People. So it's on OUR SHOULDERS, like it or not (& I actually don't like it).
I can't disagree with that and part of it I thought was controlling the Fed or better yet abolishing it altogether for their endless money printing.
"What exactly do you mean by a "debt-based currency subject to interest"?"
See "Money as Debt" for an amusing video explaining the concept at its most fundamental level.
http://video.google.ca/videoplay?docid=5352106773770802849#
These financial experts and regulators favor breaking up the big banks:
Joseph Stiglitz, Robert Reich, Simon Johnson, Neal S. Wolin, William K. Black, Nouriel Roubini, Marc Faber, R. Glenn Hubbard, Alan Greenspan, Paul Volcker, Sheila Bair.
Even the Bank of International Settlement (the Central Bank for Central Banks) supports smashing TBTF's.
http://www.washingtonsblog.com/2010/04/banking-industry-insiders-call-for.html
Break up the "too big to fail" banks and reinstate Glass-Steagall -- then, make sure that the regulators are doing their jobs as regulators!
More from the big banks -- if you haven't already read Matt Taibbi's most recent article -- this time, it's J.P. Morgan in the hot seat:
http://www.rollingstone.com/politics/story/32906678/looting_main_street
I agree with breaking up the banks. At their current size, they can put real fear into Congressmen, regulators, small countries, other banks, employees, etc. So, the overwhelming temptation is to do so instead of doing their jobs. That's a problem with all large corporations.
But more is needed, and it involves our government. Baker says large banks "pay smart people lots of money [to lobby Congress]. The banks' mouthpieces will make a conscientious regulator look like a crazed vigilante" Here, again, we see what happens when your government is for sale. Campaign finance reform, aka fixcongressfirst.org, is the only thing that will keep 'our' Congress from being in the pay of the TBTF banks.
The repeal of the Glass-Staegall Act allowed banks to also function as investment banks along with deregulation allowing higher risks. Banks make more from investments than loans, hence no loans, no money available for business.
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Once again Dean Baker--the outspoken Keynesian who says he does not often disagree with Paul Krugman, another Keynesian--fails Political Economy 101. "Break up the big banks," says Baker; without, please note, specifying what political forces are going to do this (the "agency problem", so called) and, concomitantly, whether the breakup desired will in fact occur.
The breakup desired by Mr. Baker will not occur because the political wherewithal for the breakup does not exist. There is no left movement sufficient to wrench the Congress and the Administration from their current course of succoring the status quo.
Which brings us to the question of the economic status quo: A collateral incapacity relating to Baker's failure to specify why banks (and other business institutions) are so very big now, all over the world, such that a relative handful of behemoths dominates finance, manufacturing, technology, weapons production, insurance, health care, pharmaceuticals, media, and so on. To answer this question one would have to advert to a term shunned by Messrs. Baker and Krugman, namely, "capitalism" (and its cognates). A very long time ago a rogue economist named Karl Marx spoke of the "concentration and centralization of capital" as a fundamental tendency of capitalist development. (Marx got many things wrong, but this was one he got right.) In the corporate, historical sequel to Marx,the evolution of capitalism as a system brings oligopolistic bigness that transcends national boundaries; the evolution of finance brings financial innovations that delude the financiers into thinking they have mastered risk; when reality crashes in, the masters of the universe then demand public bailouts, lest the country sink into depression. (Their economists shamelessly call this a problematic of "systemic risk").
These are the salient facts of capitalist evolution unknown to Baker and Krugman, who entertain the grandest illusion of all, namely, that capitalism is, or can be made to be, an eternal system. (The Keynesians fancy themselves the mandarins of the perpetual empire of capital, and expect to be prized as such.) The relations of production--how the system connects economically--spell oligopoly-unto-monopoly--while the forces of production--humans, scientific knowledge, machines, the earth, i.e., what gets related--either spell out "profit" or else they are discarded. (The names of the discards are legion: unemployment, outsourcing, downsizing, obsolescence, externalities, economic crisis, marginalized work, alienated labor, environmental destruction, and so on.) The property relations (laws) make all of this official via the political state, which as ever is the instrument of the ruling class, the corporate capitalist/imperialist elite.
Reformist smoke rings from the likes of Baker and Krugman are good theater inasmuch as they expose the pompous ignorance of the academic glitterati. Politics is the vehicle of economics, but these would-be saviors of capitalism peddle illusory versions of both. It is no wonder that, in the upshot of "reform," big capital somehow, sooner or later, manages to get its way.
Then when the crash comes, there is heard the same old song and dance called This Time Will Be Different (when "we" reform capitalism). Mr. Baker, your reforms would turn the clock back on capitalist evolution; which is why your reforms have as much chance of enactment as an honest thought in our nation's capital.
Wanna bet?
I think we all (well, many of us) took a bet that the ethic enforcing capitalist energy (ie personal profit) wouldn't infect the commons (ie our democracy). Alas it did. Hence, 'This Time Is Different' in that we have a government largely bought by multiple capitalist forces. so, the fight is to take back our government. We actually retain the means to do so: by popularly advocating for a change to our democracy that severs the ties between corporations and congressmen. If we can all push hard enough on this ONE thing, I think we can get it through over the objections of corporations and bought congressmen alike.
But time is short, and it is not on our side. fixcongressfirst.org
I know this is probably 'short shrift' compared to what you are actually advocating. But I see it as a single thing, a doable thing, that we can all unite behind. We need that ability, to unite behind a single thing, before this country is completely taken out of our hands.
Sadly, I don't agree with you as to the fundamental error in capitalism (as many in CD agree with you). I simply feel (as Baker probably does) that micro-capitalism contains errors when writ large, ie when it becomes macro-capitalism, and that these errors need fixing to create a society that works for all her peoples: rich and poor.
I'm with you. A mixed (public sector/private sector) economy is best & is the most accurate reflection of the real-life circumstances of the individual-in-community, & a class-type structure to that community (ie. it will not be a level, flat-lined society;there WILL BE high & middle & low). What is of greatest importance is that the general welfare, & justice, WILL BE SERVED, come hell-or-high water.
He is offering an opinion of what he thinks should happen- I doubt you attack Nader for his fantasies.
I am left of Baker too but it's counterproductive to dismiss these guys, we fail because we appear to have no aconomic credibility-no economists on our side. It's not just about coaxing liberals further to the left-the Krugman and Stiglitz types are needed to bring the center-right into reality.
I hope everyone checks out Michael Hudson's new site.
Po Thread: (1) You offer no specific criticisms of the specific conclusions that I argued. (2) Bad guess: I am one of the few on this web site repeatedly critical of Ralph Nader's fantasy valedictory book, "Only The Super-Rich Can Save Us." In fact I think Nader's last stand implies the terminal invalidism--note his "Only"--of the Left that so many on this site, such as yourself, presume as a viable entity. (3)Krugman, Stiglitz, Baker et al. will bring nobody to "reality" because they are demonstrably delusional in re same: They are bourgeois reformists, defined as those who claim that the evils of capitalism can be removed while keeping capitalism as a system. This position has no credibility, since capitalism is evidently more prolific in creating evils than reformers are in banishing them. (4) If "we" have few academic economists on "our" side, then all the better. Perhaps you have not noticed that as a class, academic economists tend to get all the big questions wrong, such as, Is economic crisis inevitable? Is there a ruling class under capitalism? Is unemployment a good thing? Is capitalism really efficient? Is capitalism eternal, or a passing historical phase? Is value constituted by utility alone? Must capitalism expand ad infinitum? How much "productivity" advancement is enough? Are human beings commodities? Are corporations persons? Can systemic risk be eliminated? Is greed good? Is egoism the best paradigm for economic agency? Does capitalism inevitably tend to oligopoly and monopoly? Can printing money ad infinitum solve capitalism's recessionary problem?
There are plenty of radical economic thinkers, present and past, you just do not know about them. Recall that Keynes, the great bourgeois reformist, dryly singled out only two "underworld" economists--S. Gesell and K. Marx--as anticipating Keynes' bad news that, after all, capitalism does not always settle into equilibrium with maximum employment.
Relax, I agree with your anti-capitalist arguments. Please take the opportunity to enlighten us to these radical economists.
I think "The Conservative Nanny State" is an invaluable read for anyone trying to convince their rightwing family and neighbors to turn left and he was one of the few mainstream economists calling for the nationalization of the banks, Why does he need to "specify which political forces" will break up the banks? and if you're Marxist doesn't that make you "of the Left?"
The problem is that the left are seen as naive on economic issues and I don't think throwing Baker and Stiglitz under a bus is gonna be productive.
It's the congress that first needs 'breaking up.'
Do this via comprehensive, progressive campaign finance reform and the solutions to many other problems will stand a chance of following.
Here's a good start to the reform we need: repeal the Financial Services Modernization Act (aka Gramm-Leach-Bliley Act) and the Commodity Futures Modernization Act. Repealing these two monstrosities alone would work wonders.