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5 Reasons We Must Break Up the Giant Banks

George Washington's picture




 

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As everyone from Paul Krugman to Simon Johnson has noted, the banks are so big and politically powerful that they have bought the politicians and captured the regulators.

But the giant banks are not only dangerous because they skew the political system. There are five economic arguments against the mega-banks as well.

Impaired Competition

Fortune pointed out last February that the only reason that smaller banks haven't been able to expand and thrive is that the too-big-to-fails have decreased competition:

Growth
for the nation's smaller banks represents a reversal of trends from the
last twenty years, when the biggest banks got much bigger and many of
the smallest players were gobbled up or driven under...

 

As big
banks struggle to find a way forward and rising loan losses threaten to
punish poorly run banks of all sizes, smaller but well capitalized
institutions have a long-awaited chance to expand.

So the very size of the giants squashes competition.

Less Loans, More Bonuses

Small banks have been lending much more than the big boys.

The giant banks which received taxpayer bailouts actually slashed lending more, gave higher bonuses, and reduced costs less than banks which didn't get bailed out.

Lack of Transparency in Derivatives

JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley together hold 80% of the country's derivatives risk, and 96% of the exposure to credit derivatives.

Experts say that derivatives will never be reined in until the mega-banks are broken up.

Increased Debt Problems

As I pointed out in December 2008:

The
Bank for International Settlements (BIS) is often called the "central
banks' central bank", as it coordinates transactions between central
banks.

BIS points out in a new report
that the bank rescue packages have transferred significant risks onto
government balance sheets, which is reflected in the corresponding
widening of sovereign credit default swaps:

The
scope and magnitude of the bank rescue packages also meant that
significant risks had been transferred onto government balance sheets.
This was particularly apparent in the market for CDS referencing
sovereigns involved either in large individual bank rescues or in
broad-based support packages for the financial sector, including the
United States. While such CDS were thinly traded prior to the announced
rescue packages, spreads widened suddenly on increased demand for
credit protection, while corresponding financial sector spreads
tightened.

In other words, by assuming huge portions of
the risk from banks trading in toxic derivatives, and by spending
trillions that they don't have, central banks have put their countries
at risk from default.

Now, Greece, Portugal, Spain and many other European countries - as well as the U.S. and Japan - are facing serious debt crises. See this, this and this.

By failing to break up the giant banks, the government is guaranteeing that they will take crazily risky bets again and again and again.

We are no longer wealthy enough to keep bailing out the bloated banks. We have serious debt problems. See this, this and this.

(Anyone
who claims that Chris Dodd's proposed "reform" legislation will prevent
banks from getting bailed out again is wrong. If the giant banks aren't
broken up now - when they are threatening to take down the world
economy - they won't be broken up next time they become insolvent, either. And see this.)

Unfair Competition and Manipulation of Markets

Moreover, Richard Alford - former New York Fed economist, trading floor economist and strategist - recently showed that banks that get too big benefit from "information asymmetry" which disrupts the free market.

Nobel prize winning economist Joseph Stiglitz noted in September that giants like Goldman are using their size to manipulate the market:

"The
main problem that Goldman raises is a question of size: 'too big to
fail.' In some markets, they have a significant fraction of trades. Why
is that important? They trade both on their proprietary desk and on
behalf of customers. When you do that and you have a significant
fraction of all trades, you have a lot of information."

Further,
he says, "That raises the potential of conflicts of interest, problems
of front-running, using that inside information for your proprietary
desk. And that's why the Volcker report came out and said that we need
to restrict the kinds of activity that these large institutions have.
If you're going to trade on behalf of others, if you're going to be a
commercial bank, you can't engage in certain kinds of risk-taking
behavior."

The giants (especially Goldman Sachs) have also used high-frequency program trading which not only distorted the markets
- making up more than 70% of stock trades - but which also let the
program trading giants take a sneak peak at what the real (aka “human”)
traders are buying and selling, and then trade on the insider
information. See this, this, this and this. (This is frontrunning,
which is illegal; but it is a lot bigger than garden variety
frontrunning, because the program traders are not only trading based on
inside knowledge of what their own clients are doing, they are also trading based on knowledge of what all other traders are doing).

Goldman also admitted
that its proprietary trading program can "manipulate the markets in
unfair ways". The giant banks have also allegedly used their Counterparty Risk Management Policy Group (CRMPG) to exchange secret information and formulate coordinated mutually beneficial actions, all with the government's blessings.

Again, size matters. If a bunch of small banks did this, manipulation
by numerous small players would tend to cancel each other out. But with
a handful of giants doing it, it can manipulate the entire economy in
ways which are not good for the American citizen.

No wonder virtually every independent economist and financial expert is calling for the big banks to be broken up.

Some argue that it is logistically impossible to break up the behemoths. But if we broke up Standard Oil, we can break up the giant banks as well.

 

 

 

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Fri, 04/30/2010 - 17:01 | 326143 AnAnonymous
AnAnonymous's picture

Same remarks as usual.

Too big to fail banks might have decreased concurrence; this  is essential in a competition. You dont thrive in a competition if you dont decrease concurrence. They have not decreased competition. Too big to fail is not contrary to competition. Only a by product of it.

In another post, the suggestion of breaking up too big to fail banks is the anti competition proposition. 

 

The second argument is no better. Banks receiving money(big banks) against banks(small banks) not receiving money. What data on big banks/small banks not receiving money?

Three: I pass. Rather self explicit imo.

Four: dont want to hammer the same point over and over again but big banks have been improving the issue of debt by shifting it on outside players.

At present stage, it is litterally as if this part of the world has no debt when some other parts of the world have seen their debt increasing. All the quoted countries are not in debt. They have only unclear promises to cover for other countries' debts in an imprecise near future. Money is not a variable here.

Manipulation of the market? What does this mean?

Fri, 04/30/2010 - 15:34 | 325982 Econophile
Econophile's picture

George:

I am shocked by this post from you.

You should know as well as anyone that no one is too big to fail. The problem isn't size, it's the moral hazard created by government programs and policies that backstop these guys. You are inviting another layer of regulation that won't stop at the Big Boys and you well know that.

You are empowering the government to compound the errors and strengthen its all-seeing-all-knowing role over the economy.

The solution is to take away the backstop insurance propping these guys up and then we won't have to bail them out.

Fri, 04/30/2010 - 16:48 | 326113 AnAnonymous
AnAnonymous's picture

Too big to fail only fail when the supporting structures crumble.

Only things designed not to fail like capitalism never fails.

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