Thursday, September 6, 2012

Don't make banks too small to succeed

In his Bloomberg editorial, Phillip Swagel takes on Simon Johnson's call for breaking up the big banks and makes the counter-argument for not making banks too small to succeed.

Your humble blogger has talked and exchanged emails with both of these individual so I can say unequivocally that they are both very bright, thoughtful individuals.

I can also say that when it comes to talking about breaking up the banks, they are both wrong.

They are wrong because both would use a regulatory process for determining what is the optimal size of a bank.  There is no reason to believe that the regulators will get it right.

The much better way to get the banks to their optimal size is by requiring the banks to provide ultra transparency and disclose on an on-going basis their current global asset, liability and off-balance sheet exposure details.

As the Bank of England's Andy Haldane said in his Jackson Hole 2012 speech, the market will apply heuristics to make sense of this disclosure.

The first heuristic it will apply is any entity with 3,000+ subsidiaries is too complicated for any one person to understand.  If it is too complicated, it must be risky.  This simple heuristic will put pressure on the big banks to shrink themselves (the pressure comes as investors adjust for the risk of the banks in the form of lower stock prices).

How much do they need to shrink?  I don't know nor does anyone else.

What is clear is that the pressure to shrink will not abate until the risk in each of these banks can be understood.

Calls by former Citigroup Inc. Chief Executive Officer Sanford Weill and others to break up the big banks reflect lingering public fear and anger toward financial institutions that seem too big to fail. 
These calls, however, ignore the unintended consequences of making our global banks too small to succeed: Much of the business will migrate to non-U.S. banks and the less-regulated shadow banking sector. Weill and the rest also neglect to consider key reforms that protect taxpayers from a potential failure.

No comments: