If We Don't Break Up the Giant Banks NOW, They'll Be Bailed Out Again and Again ... Dragging the World Economy Down With Them

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Washington’s Blog

I warned last year:

who thinks that Congress will use the current financial regulation -
Dodd-Frank - to break up banks in the middle of an even bigger crisis
is dreaming. 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. In other words, there is no better time than today to break them up.

Standard and Poors is providing evidence for this assertion.

As the Financial Times notes today:

Officials fighting the next financial crisis may again bail out banks using
the public purse, S&P has said, in an opinion that casts doubt on
one of the fundamental tenets of US financial reform.

rating agency said on Wednesday that the US Treasury, Federal Reserve
and Congress might rescue a large financial group rather than allow it
to fail like Lehman Brothers. Dodd-Frank, the legislation signed into
law a year ago next week, was supposed to prevent bail-outs by allowing
the government to seize and wind down safely an ailing "systemically
important financial institution", or Sifi.

But in a research
note, S&P said: “We believe the government may try to avoid
contagion and a domino effect if a Sifi finds itself in a financially
weakened position in a future crisis.”

The agencies’ views are
crucial to the fight over whether the phenomenon of “too big to fail”
has been ended. If not, the largest banks will continue to enjoy a
funding advantage over their smaller rivals.

And see this (written after the passage of Dodd-Frank).

Why Break Up the Giant Banks?

all independent economists and financial experts say that the giant
banks are too big, and that their very size is hurting the economy:

  • Dean
    and professor of finance and economics at Columbia Business School,
    and chairman of the Council of Economic Advisers under President
    George W. Bush, R. Glenn Hubbard
  • Former Tarp overseer and creator of the Consumer Financial Protection Bureau, Elizabeth Warren
  • The leading monetary economist and co-author with Milton Friedman of the leading treatise on the Great Depression, Anna Schwartz
  • Economics professor and creator of the "efficient market hypothesis", Eugene Fama
  • Economics professor and senior regulator during the S & L crisis, William K. Black
  • Professor of entrepreneurship and finance at the Chicago Booth School of Business, Luigi Zingales

Why do these experts say the giant banks need to be broken up?

Well, small banks have been lending much more than the big boys. The giant banks which received taxpayer bailouts have been harming the economy by slashing lending, giving higher bonuses, and operating at higher costs than banks which didn't get bailed out.

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

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...


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, and prevents the small and medium size banks to start lending to Main Street again.

And as I noted in December 2008, the big banks are the major reason why sovereign debt has become a crisis:

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

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:

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

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.

A study of 124 banking crises by the International Monetary Fund found that propping banks which are only pretending to be solvent hurts the economy:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.


analysis to date also shows that accommodative policy measures (such
as substantial liquidity support, explicit government guarantee on
financial institutions’ liabilities and forbearance from prudential
regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.



All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway.
Also, closure of a nonviable bank is often delayed for too long,
even when there are clear signs of insolvency (Lindgren, 2003). Since
bank closures face many obstacles, there is a tendency to rely
instead on blanket government guarantees which, if the government’s
fiscal and political position makes them credible, can work albeit at
the cost of placing the burden on the budget, typically squeezing future provision of needed public services.

Greece, Ireland, Portugal, Spain, Italy and many other European
countries - as well as the U.S. and Japan - are facing serious debt
crises. We are no longer wealthy enough to keep bailing out the bloated

Indeed, the top independent experts say that the biggest banks are insolvent (see this, for example), as they have been many times before. By failing to break up the giant banks, the government will keep taking emergency measures (see this and this) to try to cover up their insolvency. But those measures drain the life blood out of the real economy.

And by failing to break them up, the government is guaranteeing that they will take crazily risky bets again and again, and the government will wrack up more and more debt bailing them out in the future.

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.

Indeed, Nobel prize-winning economist Joseph Stiglitz has noted that giants like Goldman are using their size to manipulate the market:

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."

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 distorts the markets
- making up more than 70% of stock trades - but which also lets the
program trading giants take a sneak peak at what the real (that is,
human) traders are buying and selling, and then trade on the insider
information. See this, 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".

Moreover, 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 - and see this - even though the lack of transparency in derivatives is one of the main risks to the economy.

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.

Further, fraud was one of the main causes of the Great Depression and the current financial crisis. The banks are so big that they are buying off politicians so that it has become official policy not to prosecute fraud. Indeed, everyone from Paul Krugman to Simon Johnson has said that the banks are so big and politically powerful that they have bought the politicians and captured the regulators. So their very size is allowing economy-killing corruption to flourish.

the banks' enormous size means that the executives make orders of
magnitude more in bonuses and salary than the executives of small banks.
They are so big that their executives are living like kings. This is
making inequality worse ... and rampant inequality was another primary cause of the Great Depression and the current financial crisis.

Indeed, failing to break up the big banks will result in the sale of national assets and the looting of national treasuries in order to pay off debts to the giant banks. This, in turn, will destroy the national sovereignty of virtually every country.

Leading independent bank analyst Christopher Whalen argues:

fraud and obfuscation now underway in Washington to protect the
TBTF [i.e. giant or "too big to fail"] banks ... totals into the
trillions of dollars and rises to the level of treason.

Just look at Greece. That is our future - and see this - unless we break up the "too big to fails".

These concepts have been known for hundreds of years:

a government is dependent upon bankers for money, they and not the
leaders of the government control the situation, since the hand that
gives is above the hand that takes... Money has no motherland;
financiers are without patriotism and without decency; their sole object
is gain."

- Napoleon Bonaparte

"There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt."
- John Adams

the American people ever allow the banks to control issuance of their
currency, first by inflation and then by deflation, the banks and
corporations that grow up around them will deprive the people of all
property until their children will wake up homeless on the continent
their fathers occupied”.

— Thomas Jefferson

believe that banking institutions are more dangerous to our
liberties than standing armies...The issuing power should be taken
from the banks and restored to the Government, to whom it properly

- Thomas Jefferson

was] the poverty caused by the bad influence of the English bankers
on the Parliament which has caused in the colonies hatred of the
English and . . . the Revolutionary War."
- Benjamin Franklin

Founding Fathers of this great land had no difficulty whatsoever
understanding the agenda of bankers, and they frequently referred to
them and their kind as, quote, ‘friends of paper money. They hated the
Bank of England, in particular, and felt that even were we successful
in winning our independence from England and King George, we could
never truly be a nation of freemen, unless we had an honest money
system. ”
-Peter Kershaw, author of the 1994 booklet “Economic Solutions”

creation and circulation of bills of credit by revolutionary
assemblies...coming as they did upon the heels of the strenuous efforts
made by the Crown to suppress paper money in America [were] acts of
defiance so contemptuous and insulting to the Crown that forgiveness
was thereafter impossible . . . [T]here was but one course for the
crown to pursue and that was to suppress and punish these acts of
rebellion...Thus the Bills of Credit of this era, which ignorance and
prejudice have attempted to belittle into the mere instruments of a
reckless financial policy were really the standards of the Revolution.
they were more than this: they were the Revolution itself!"

- Historian Alexander Del Mar

British Parliament took away from America its representative money,
forbade any further issue of bills of credit, these bills ceasing to
be legal tender, and ordered that all taxes should be paid in coins
... Ruin took place in these once flourishing Colonies . . .
discontent became desperation, and reached a point . . . when human
nature rises up and asserts itself."

- British historian John Twells