Last week, Senators Sherrod Brown and Ted Kaufman introduced a bill that would break up the biggest financial institutions and cap bank sizes so that they can never get so big again. Senate Banking Committee Chairman Christopher Dodd (so far) hasn't bought it, and the administration hasn't bought it, and the biggest banks aren't keen on it. Yet it might be the single most important piece of financial reform legislation currently under consideration, and is the only legislation on the table that could protect against what should be our two biggest worries: 1) another major meltdown driven by financial institutions that aren't worried about failure, and 2) an economy run by uncompetitive, enormous financial institutions that distort the market because they are too big to be bothered to compete.
Typically, when confronted with the prospect of breaking up big banks, bankers and their apologists argue that socially useful economies of scale will be endangered. But it's worth asking: What are the economies of scale that come along with a bank that has, say, $2.2 trillion dollars in assets? (That's Bank of America.) Given that our six largest banks are now collectively worth more than 60 percent of the U.S. gross domestic product, it's a burning question.
When it comes to socially useful services"â?lending, deposits"â?there is lots of research and no evidence that the enormous banks provide better services or the same services at lower costs. Even if you want to get in the weeds of the debate about bank size inside the economics literature, the debate is about whether the economies of scale drop off at $200 million in assets, $500 million in assets, or $50 billion in assets"â?much smaller than the scale we're talking about.
The problem is that in the last decade, the banking industry has become so concentrated that it no longer functions as a competitive market. This is not a view held exclusively on the left. As conservative economist Arnold Kling said in a recent National Review article, "Big Banks are bad for free markets. Far from being engines of free enterprise, [megabanks] are conducive to what might be called 'crony capitalism.'"?
The big argument from the banks when they successfully dismantled regulations in the '90s was that if we didn't deregulate, American banks would just lose out to foreign banks. This argument hasn't served us well so far, clearly. Moreover, we're not talking small banks, by any means"â?a bank capped under the proposed Brown Amendment is still bigger than banks from other countries. More importantly, we are the world leaders in banking, and other countries are already moving toward size caps"â?if we do a size cap, the countries that haven't yet will follow. Moreover, because there are no demonstrable advantages to consumers for the existence of big banks, those banks that are too big will just end up burdening other governments' treasuries when they fail"â?and the American system will be more stable, and therefore more competitive, in both the short and long term.
There is actually one place where bigness yields clear economies of scale: in lobbying, a form of what economists call "rent-seeking."? That is, companies "seek"? to make earn income by using political connections to manipulate laws, instead of by making better products. Goldman Sachs (GS) is probably Exhibit A in terms of working the economies of scale in rent-seeking. That's why they aren't too worried about the Brown/Kaufman bill (yet), because they are pretty sure they have Congress and the executive branch covered, by years of ideological capture, dinner parties, kids at the same schools, revolving doors, and direct campaign contributions.
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