Opinion

Felix Salmon

The systemic threat posed by megabanks

By Felix Salmon
August 31, 2009

Just a gentle reminder, if you haven’t got around to it yet, that you really have to read David Cho’s piece (and graphical sidebar) on how the too-big-to-fail banks are growing, both in size and profitability, at the expense of small-enough-to-fail institutions:

J.P. Morgan Chase, an amalgam of some of Wall Street’s most storied institutions, now holds more than $1 of every $10 on deposit in this country. So does Bank of America, scarred by its acquisition of Merrill Lynch and partly government-owned as a result of the crisis, as does Wells Fargo, the biggest West Coast bank. Those three banks, plus government-rescued and -owned Citigroup, now issue one of every two mortgages and about two of every three credit cards, federal data show…

In the last quarter, the top four banks raised fees related to deposits by an average of 8 percent, according to research from the Federal Reserve Bank of Dallas. Striving to stay competitive, smaller banks lowered their fees by an average of 12 percent…

Large banks with more than $100 billion in assets are borrowing at interest rates 0.34 percentage points lower than the rest of the industry. Back in 2007, that advantage was only 0.08 percentage points, according to the FDIC. Such differences can cause huge variance in borrowing costs given the massive amount of money that flows through banks.

It’s urgent that the government (probably through the FDIC) start imposing a surcharge on bank size. If this state of affairs is allowed to continue, there will be hundreds of unnecessary bank failures — maybe there already have been. And rather than the big banks getting smaller — which is what makes sense, from the point of view of the amount of systemic damage they can cause — they will continue to get bigger.

It wasn’t all that long ago that the 10% cap on national deposits was taken seriously: now it has been left far behind, even as the total deposit base has increased substantially. Wells Fargo, JP Morgan Chase, and Bank of America pose a real systemic threat to the US economy. They should be forced to start shrinking today.

Comments
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The US suffers from two really BIG problems: big business and big government. We learned about the dangers of big business during the Robber Baron Anti-Trust Era early in the 20th century, and then gradually developed almost total amnesia about its flagrant abuses. Now that the return of Really Big Business has created a host of systemic problems for us to deal with, we are forced to employ the other powerful but dangerous tool: Big Government. The founding fathers understood the dangers of concentrated power and made sure there was a separation of powers to provide checks & balances, but they probably couldn’t foresee that Big Business interests could get so powerful that they could buy government. Nor that the American people could get so complacent that they would accept Big Business dominating all aspects of their lives. With tv to hypnotize and dumb down the masses, and sacks full of special interest money to buy politicians, there is literally nobody minding the fort. Even economists are guilty of sucking up to Big Money and endorsing ruinous policies that are bankrupting the nation. All we have left is a sage populist President with a mandate for change and a wary Congress beseiged by determined special interest lobbyists. The Big Banks that used their clout to get derivatives full of crappy subprime mortgages declared AA Investment Grade by their rating agencies and thereby instituted the largest financial scam in the history of capitalism are lobbying hard to escape any regulatory restraints on their imprudent risk-taking with Other People’s Money. And, still, the American sheeple are silent and placidly browsing just outside the slaughterhouse door. Having just been sheared, they are simply too terrified to contemplate what will come next if they do not act.

Posted by Alan | Report as abusive
 
 

Please, Felix. By international standards, the US credit market is unduly fragmented, due to legislation dating back to the local equivalent of the Middle Ages. Banks have a small market share each and their individual balance sheet is ridiculously small. This makes for a highly dysfunctional, lopsided and instable banking system, which has had to unduly rely on securitisation to operate, which in the end put us all in this mess we’re in. Oh, and that the FDIC is an institution meant for regulating small banks is quite irrelevant to the argument. Fix the b….y FDIC instead of preventing needed industry consolidation. Merge it with some of the umpteen other regulatory midgets that are supposed to regulate banking and financial markets, but don’t, and have proved their total irrelevance and ineptitude.

Posted by Henri Tournyol du Clos | Report as abusive
 

Yay! More government control! Just what we need. They do such a fantastic job now, let’s give them even more power! You are brainwashed Felix.

Posted by Jon | Report as abusive
 

I don’t think the 10% rule was ever slated for obsolescence, but it seemed better to have JPM buy BSC and WM than not to have a buyer — in part because JPM is in good shape right now. Similarly WFC. (The Lewis-Thain experiment in tying two rocks together to see whether they float makes somewhat less sense to me, even on expediency grounds.)

That JPM and WFC look solid right now is very good, but a problem with a TBTF bank is unsolvable by the time it’s evident, and we should certainly go about encouraging them to shrink before they look shaky. Gary Becker suggested (http://online.wsj.com/article/SB1237598 49467801485.html) that reserve requirements scale faster than linearly as banks get big, which seems to address exactly the point. For the time being, though, it might make sense to lower reserve requirements for smaller banks, rather than raise them for larger ones; in any case, there’s no good reason to put off aligning the private incentives with the public costs, which are obviously much higher for very large banks.

 

Welcome to USA = United Socialist Americas. It was always a demand of socialists that major industries / banks get nationalized, this system secured by a vast surveillance bureucracy, and financed by the miraculous money making machine – a big computer producing a few additional zeros.

What happens if socialism is introduced in Sahara ?
Sand becomes rare.

Maybe the idea of having essential foodstuff in stock for – say – six months to meet a “money problem” is not that bad at all, but do not mention that too loudly.

 

“Maybe the idea of having essential foodstuff in stock for – say – six months to meet a “money problem” is not that bad at all, but do not mention that too loudly.”

Very very good idea. Means building grain storage elevators (shovelling cement at -40C isn’t fun though) and the grain turning and cooling machinery. Costs around 2% of grain price to store annually.

Some bank business lines are more important than others. I like small business loans more than I like farm loans (say grain storage equipment and credits) more than low income (transit) loans more than capital equipment loans more than distressed public University R+D more than commercial real estate more than bloated home loans more than car loans more than derivatives “innovations”. Maybe the correct strategy is to get a good ratio of small business to derivatives activities and charge a tax/deposit for being so creatively innovative?

Posted by Phillip Huggan | Report as abusive
 

Have there ever been examples of a banking system with tiered fees based on assets or some other category? I think it would be tough to implement when the lobby is heavily tilted to the largest banks.

This may be a complete non-starter, but would it be possible to force the banks over the deposit cap limit to rent their excess deposits out to other banks?

 

Small banks fail, because their geographic diversification is weak. Truly national banks, of the TBTF class, tend to have loans out everywhere they operate, so they have that weakness covered.

TBTF banks are a systemic risk only inasmuch as they have trading and securitization divisions.

Posted by mutant_dog | Report as abusive
 

So once again Felix Salmon looks at the facts, puts some of them together and, in this case, makes intelligent observation about bank size. And then once again I find inane comments about socialism infecting the United States from readers who have no understanding of history, no knowledge based in fact and no ability to keep their (truly) stupid comments to themselves. We are quickly becoming a nation so far from “exceptional” that it stuns me. But thanks for trying to inform, Mr. Salmon. Too bad about all of the deaf ears who appear to read you, however.

Posted by just a person | Report as abusive
 

Didn’t everyone get the memo – we’re suppsoed to let corporations take in a bunch of conusmer money, redistribute it to the top 5% of their employees, then fail, threaten the country with oblivion, get government bailouts to stabilize their finances, and then repeat the whole process on a bigger scale.

Any interference with that cycle is socialist. The government has no business interfering/regulating unless said interference is to give the companies more money. Any other interference makes it harder for the companies to make even more money, which is clearly anti-American.

Posted by PM | Report as abusive
 

How about we promote small regional banks and boutique investment firms. Allow them to be competitive with the larger firms and allow the market to determine where deposits go. Allow private equity to be real participants in these bank takeovers. Increase market competition and level the playing field for everyone, thats how you deal with too big to fail nonsense. Promoting a tax on large deposit institutions that you feel are to large will only increase the cost to people holding deposits in those institutions. For the life of me I can understand where you come up with these nonsense ideas, I know you play to the populist tendency of your readers, but have some common sense. BTW they already pay fees to the FDIC, look how well that has worked out. Government solves nothing!

Posted by Dogma | Report as abusive
 

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