Home > #OWS, finance > Why we should break up the megabanks (#OWS)

Why we should break up the megabanks (#OWS)

Today is May Day, and my Occupy group and I are planning to join in the actions all over the city this afternoon. At 2:00 I’m going to be at Cooper Square, where Free University is holding a bunch of teach-ins, and I’m giving one entitled “Why we should break up the megabanks.” I wanted to get my notes for the talk down in writing beforehand here.

The basic reasons to break up the megabanks are these:

  1. They hold too much power.
  2. They cost too much.
  3. They get away with too much.
  4. They make things worse.

Each requires explanation.

Megabanks hold too much power

When Paulson went to Congress to argue for the bailout in 2008, he told them that the consequences of not acting would be a total collapse of the financial system and the economy. He scared Congress and the American people to such an extent that the banks managed to receive $700 billion with no strings attached. Even though half of that enormous pile of money was supposed to go to help homeowners threatened with foreclosures, almost none of it did, because the banks found other things to do with it.

The power of megabanks doesn’t only exert itself through the threat of annihilation, though. It also flows through lobbyists who water down Dodd-Frank (or really any policy that banks don’t like) and through “the revolving door,” the men and women who work for Treasury, the White House, and regulators about half the time and sit in positions of power in the megabanks the other half of their time, gaining influence and money and retiring super rich.

It is unreasonable to expect to compete with this kind of insularity and influence of the megabanks.

They cost too much

The bailout didn’t work and it’s still going on. And we certainly didn’t “make money” on it, compared to what the government could have expected if we had invested differently.

But honestly it’s too narrow to think about money alone, because what we really need to consider is risk. And there we’ve lost a lot: when we bailed them out, we took on the risk of the megabanks, and we have simply done nothing to return it. Ultimately the only way to get rid of that costly risk is to break them up once and for all to a size that they can reasonably and obviously be expected to fail.

Make no mistake about it: risk is valuable. It may not be quantifiable at a moment of time, but over time it becomes quite valuable and quantifiable indeed, in various ways.

One way is to think about borrowing costs and long-term default probabilities, and there the estimates have varied but we’ve seen numbers such as $83 billion per year modeled. Few people dispute that it’s the right order of magnitude.

They get away with too much

There doesn’t seem to be a limit to what the megabanks can get away with, which we’ve seen with HSBC’s money laundering from terrorists and drug cartels, we’ve seen with Jamie Dimon and Ina Drew lying to Congress about fucking with their risk models, we’ve seen with countless fraudulent and racist practices with mortgages and foreclosures and foreclosure reviews, not to mention setting up customers to fail in deals made to go bad, screwing municipalities and people with outrageous fees, shaving money off of retirement savings, and manipulating any and all markets and rates that they can to increase their bonuses.

The idea of a financial sector is to grease the wheels of commerce, to create a machine that allows the economy to work. But in our case we have a machine that’s taken over the economy instead.

They make things worse

Ultimately the best reason to break them up right now, the sooner the better, is that the incentives are bad and getting worse. Now that they live in a officially protected zone, there is even less reason for them then there used to be to rein in risky practices. There is less reason for them to worry about punishments, since the SEC’s habit of letting people off without jailtime, meaningful penalties, or even admitting wrongdoing has codified the lack of repercussions for bad behavior.

If we use recent history as a guide, the best job in finance you can have right now is inside a big bank, protected from the law, rather than working at a hedge fund where you can be nabbed for insider trading and publicly displayed as an example of the SEC’s new “toughness.”

What we need to worry about now is how bad the next crash is going to be. Let’s break up the megabanks now to mitigate that coming disaster.

Categories: #OWS, finance
  1. May 1, 2013 at 7:54 am

    Cathy,

    Far be it for me to tell *you* anything about the financial world, but….

    I don’t think the ‘too much power’ argument, even if true, provides the best starting point. I’d suggest that there might be more effective framings of your argument.

    As our economy has evolved over the last decade or two, the megabanks have become organizations which, in spite of their size, weaken the economy, not strengthen it. They do so because they make our economy more, not less, fragile. They decrease economic resilience. We’ve got data to back up that assertion.

    But, there is a tough human cognitive bias that makes seeing this more difficult. Large things appear to us to be more stable…less moveable….things which appear to contribute to stability by the very inertia they add to the system. But, it’s an illusion.

    Maybe a helpful analogy is agriculture. Imagine if we just had one or two huge tractors that could plow and till and harvest tens of thousands of acres per hour. This would be an awesome machine. Watching it work, we might feel some pride as human creators of such a powerful device. And the tractor drivers? You can imagine how they would feel driving this around the world’s fields.

    But, if that megatractor broke down in a serious way…we’d starve.

    Social and economic resilience is better achieved through networks of right-sized components, including banks.

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    • May 1, 2013 at 9:34 am

      Good points. I’ll add them to the last section.

      Like

    • Josh
      May 1, 2013 at 10:58 am

      @rbookman: I agree with you. But I am curious what you are thinking of when you say there is data to back up the assertion. Of course there was the huge blowup which can certainly be taken as evidence but the tie between size (which isn’t really the main problem, anyway) and fragility isn’t clear. I’m interested in whether you are thinking of more direct and more precise analyses.

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      • May 2, 2013 at 8:35 am

        @Josh:
        I was thinking about two threads in the (largely academic) literature – one focused on the notion of ‘economic resilience’ and the other from systems engineering.

        I don’t want to get to hung up on the word ‘size’…and would rather be a bit more mathy (after all, we are in Cathy’s house here!) and remember that ‘size’ depends, in a measure theory sort of way, on the ruler you use.

        With that in mind, as @badmax is suggesting below, LTCM was ‘big’….because snapping the branch shook the trunk, albeit transiently.

        Lastly, Cathy’s interconnectedness comment suggests one of the rulers we might include in our definition of ‘size’. But, ‘economic nodes being connected’ needs a bit more detail.

        What is the nature of the link? What are the impedance properties of that link? How are signals transmitted from one node to another? Are they band-limited?

        Just another way of framing….

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  2. badmax
    May 1, 2013 at 9:53 am

    Perhaps it might be He who Walks Behind the Rows who is driving said tractors MUHAHAHA

    …but seriously, when you say ‘break up the megabanks’, what metric do you mean exactly? Break them up by headcount? By division? By deposit base? Geography?

    I see numerous difficulties with all of these delineations. For instance the headcount and deposit base of LTCM was comparatively infinitesimal and they only had one division (asset management) but look at what they did.

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    • May 1, 2013 at 9:55 am

      Yes it’s not just about size, it’s about interconnectivity.

      Like

      • Zathras
        May 1, 2013 at 9:58 am

        Exactly. Reinstating Glass Steagall would say nothing about HC’s or geographies, but it would make an important blow in breaking this interconnectivity.

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  3. Zathras
    May 1, 2013 at 10:03 am

    I do have to disagree about the bailout not working. It is because of that tremendous power and interconnectivity that Paulson was unfortunately right, that allowing all of the banks to implode would really have destroyed the economy. Long term and short term credit is an essential part of the way international trade works, and that was about to disappear. Trillions in peoples’ deposits were about to simply disappear. The way the bailout was done did perpetuate the power of the banks; it would have been much better to get them in a receivership where they could have been broken up. But if the choice was between doing nothing and doing what was done, doing what was done is the only choice.

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    • May 1, 2013 at 10:22 am

      It’s a propagated myth that those were the only options.

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      • Zathras
        May 1, 2013 at 10:32 am

        I totally agree. I’m just saying that what was done was better than doing nothing.

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        • P
          May 2, 2013 at 2:55 pm

          FDIC insurance would still have applied. Contracts would still have applied. I don’t see how deposits would have disappeared. People in money-market funds might not have access to their money for a few days, and there might have been a few weeks of forcing banks to process payments while in receivership while the new equity structures are sorted out. A little painful, but $800b ($3k per US citizen) covers up a little pain.

          The bailout did work in the sense of keeping things as they were …

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  4. Josh
    May 1, 2013 at 11:21 am

    I agree that breaking them up has practical difficulties.

    There is an alternative approach that has a lot of appeal and is gaining political traction — requiring substantially more equity capital. There is an argument that this should be done for all banks because if a bank becomes distressed, it has incentives to increase its risk. But it is most compelling for megabanks (or what I prefer to call “systemically threatening institutions” (STIs) because their real distinguishing feature is that their failure would threaten the financial system more generally (as was pointed out, LTCM qualified even though small).

    Forcing them to have more equity would do two things directly
    1) It would directly reduce the risk of failure (and the cost to the taxpayer of failure).
    2) it would give shareholders (and, to a lesser degree, management) better incentives to manage risk

    This would not force them to break up but it likely would lead them to do so. If you believe that most of the megabank/STIs profits come from the implicit subsidy, they would become much less profitable and there would be pressure from the shareholders to address this.

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  1. May 2, 2013 at 2:02 am
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