Deconstructing Banks

June 16, 2012

When journalist Matt Taibbi lets fly, you know that you’re in for quite a ride. In March he targeted Bank of America, and his exposé in Rolling Stone was an eye-opener. Even I thought I was immune from outrage after reading so many accounts of the misadventures and villainy of bankers—but I was wrong.

Taibbi starts the article by describing Bank of America as “a hypergluttonous ward of the state whose limitless fraud and criminal conspiracies we’ll all be paying for until the end of time.” Cataloging its astonishing variety of crimes, Taibbi concludes that “the government bailouts succeeded in doing was to make the bank even more prone to catastrophic failure” as it pursues ever more risky strategies to get itself out of a very deep hole.

While Obama is tut-tutting Europe and its dysfunctional banking sector, little is said about Bank of America, whose credit rating sits a few rungs above junk status, and that assessment may well flatter its current dire financial situation. To top it off, the executives who run the bank showed no shame. In 2010, they paid themselves $35 billion in bonuses and compensation, presumably feeling that a pre-tax loss of only $5.4 billion was a major accomplishment.

We no longer have a capitalist system that Adam Smith would recognize. Large banks are a protected species that no longer have to worry about the judgment of the market. They know that whenever they make a misstep, and their missteps often run into the billions, they will have an ever-forgiving government there to dust them off and cover their losses. Business success no longer means making a profit in a competitive market. In the 21st century, it means being sufficiently large so that the government can’t afford to let them fail; otherwise, they will bring down the rest of the economy with them.

When you read about the debt crisis in the US, Europe, and elsewhere, the problem is not always spendthrift governments. Too often, governments only get into trouble when they decide to take on the debts of their failing banks. What makes the situation even more tragic is that once these banks have been put on life-support, they close off access to loans that small companies need to obtain in order to grow. It is these small companies that provide jobs, but without capital, these otherwise profitable firms could go under.

In another article, Taibbi looks at how business lobbyists have helped roll back the meager reforms that had been established to address the excesses of the banking sector. He concludes, “The giant reform bill turned out to be like the fish reeled in by Hemingway’s Old Man—no sooner caught than set upon by sharks that strip it to nothing long before it ever reaches the shore.”

But don’t fool yourself that we aren’t still vulnerable. The big banks are bigger than ever and today control 52% of assets.  Not only are they big, but they are incredibly complex. At the height of the global financial crisis, CEOs of the big banks all but admitted that they had little understanding of the level of risk they were carrying.

What’s the alternative to what could best be described as partial nationalization of banks by taking on their losses?  Currently, the solution is producing thick volumes of legislation to manage the banks. This ignores the fact that even before the legislation has been signed off, the big banks have engaged smart lawyers to identify loopholes that they can exploit. The best answer is quite simple. Governments need to force big banks to reorganize, by which I mean downsize. By breaking up the banks, none will be too-big-to-fail, and the economy will get a boost through increased competition.

One of the arguments against reducing the size of banks is that only large banks have a sufficiently large pool of capital necessary to fund global deals. The simplest way around this so-called problem is to come together in consortia to finance large projects.

The beauty of this solution is that it requires very little legislation, just a simple requirement that no bank can exceed a specific size by a certain date.  At some point politicians need to take a stand and defend not only the public interest but capitalism itself from the destructive instincts of bankers who are no friends to the free-enterprise system.

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