Business Columns & Blogs

Breaking up is so very hard to do — for banks

Neel Kashkari, then assistant secretary of the Treasury Department, arrives on Capitol Hill in September 2008.
Neel Kashkari, then assistant secretary of the Treasury Department, arrives on Capitol Hill in September 2008. AP

Neel Kashkari, the new Minneapolis Fed president, has great energy to break up financial institutions designated “too big to fail.” His recent effort was a conference on April 4, with experts on both sides of the issue.

The basic premise is that, despite the Dodd-Frank Act of 2010, our economy remains vulnerable to the failure of big financial institutions. The collapse of one could throw the economy back to a situation like 1933, with output down by a third and unemployment over 30 percent. The solution, he and others argue, is not micromanagement ala Dodd Frank. Instead, break up big banks.

I agree with this view and have argued it since 2009. I am not alone: Economists far more distinguished than me make the case well. Moreover, the Minneapolis Fed was warning on “too big to fail” 25 years ago. At that time, it did not necessarily advocate breaking up large institutions, but the warnings proved correct in 2007-09.

The financial sector, particularly Wall Street, joined most Republicans in Congress in opposing Dodd-Frank. These politicians long have argued for its repeal and replacement with “common-sense legislation.” But no concrete plan has ever emerged.

GOP officials continue to snipe at features of the bill, in particular the Consumer Financial Protection Bureau. But the financial sector has moved on. Its leaders clearly think there are worse evils, so Dodd-Frank is the mast to which they cling.

Tim Pawlenty, head of the Financial Services Roundtable, laid out its response the day after the forum.

Pawlenty, former governor of Minnesota, is thoughtful and an effective industry rep. Dodd-Frank innovations, including higher capital requirements and the pre-planning to wind down failing firms, indeed are concrete improvements.

On the negative side, the act created regulatory requirements that sap economic efficiency.

The key question remains: Are the measures presented as adequate alternatives to breaking up big banks substantial enough to weather future financial panics? Many doubt that.

Simon Johnson, a MIT professor and former chief economist at the International Monetary Fund, is one doubter. He proposes a ceiling on the assets of any particular bank at 2 percent of GDP. That would be about $330 billion right now; the assets of Goldman Sachs at the end of 2015 surpassed $860 billion.

Patrick Kehoe, Minneapolis Fed Research Department star, argues that these proposed measures are highly disproportionate to the danger posed. Others argue large banks achieve economies of scale that represent real efficiencies in using resources.

The devil is in details. Those of breaking up the existing mega-banks are daunting. Aaron Klein, from the Brookings Institute, focused on these practical considerations. Banks ordered to downsize will shed their least profitable operations. That may involve closing bank branches, hurting mom-and-pop customers and employees such as tellers but not really reducing risk. Some communities will have less competition or even no local banking services at all, he argues. Multinational corporations may experience difficulty moving money.

Eugene Ludwig, a banker and comptroller of the currency under Bill Clinton, offered the traditional economist’s advice that more study is needed.

Consider a few comments.

First, the economies of scale argument is a classic fallacy of composition. Just because a large bank can use resources more efficiently does not mean that a nation with many large banks is more economically efficient when one considers the risk to the whole financial system engendered by extreme market concentration. Furthermore, the financial sector is much more concentrated now than it was only 20 years ago. Corporations were not burdened by inadequate services in 1995, when the market shares of large firms were much smaller than now, nor was the overall economy less productive.

Accept the warning of harm to retail customers skeptically. Banks would have you believe that if Goldman Sachs or Citigroup are broken up, Archie and Edith Bunker won’t have any place for their savings account.

We are blessed with a vibrant independent banking sector. Small- and medium-sized community and regional banks offer good services in most areas. Technology is making physical location less important. There are many ways that adequate financial services can remain available in all communities even if the 41 or so largest banks get split up. In fact, ending TBTF would make community banks more viable because right now they struggle against bigger banks having a competitive edge in drawing deposits simply because of the implied government protection.

We should thank Bernie Sanders for making TBTF an issue in the presidential campaign. Unfortunately, his understanding of the issues is not deep. Simply putting a new cover sheet on the Glass-Steagall Act passed eight decades ago and re-introducing it in Congress isn’t going to work. And while he can argue that there is some statutory authority for the Fed and Treasury to break up big banks without any new legislation, as a practical matter this will only happen if Congress passes legislation to do it. Good luck with that in today’s world.

Kashkari is energetic, but understand that he has no power at all beyond his soapbox. Federal Reserve district presidents like him do get to take their turns as voting members of the monetary policy-setting Federal Open Market Committee. But decisions on Fed regulatory strategies are set by the seven-person Board of Governors in Washington. Full stop. District presidents can propose, but the Board disposes and only to the extent that Congress allows it to.

Former Comptroller Ludwig is right. This needs more study. But the fact that breaking up the big institutions is on the table for discussion is a heartening development.

St. Paul economist and writer Edward Lotterman can be reached at