Bernie Sanders has run an impressive campaign which has gotten him more traction than anyone could have predicted even just a few months ago. He has run on a platform of fighting for the common people and reducing inequality. One of his action items to that end is to break up the big banks. Here is how he describes it on his website:
Breaking up huge financial institutions so that they are no longer too big to fail. Seven years ago, the taxpayers of this country bailed out Wall Street because they were too big to fail. Yet, 3 out of the 4 largest financial institutions are 80 percent bigger today than before we bailed them out. Sen. Sanders has introduced legislation to break these banks up. As president, he will fight to sign this legislation into law.
Sounds like a good plan, right? The rallying cry is pretty simple and effective. “If a Bank is too big to fail, it is too big to exist.” The genesis for this post was a story about how 170 respected economists have signed a letter in support of Bernie’s proposal on busting up big banks (which can be found here.) But what are the facts around this proposal? Is it a good idea?
The presumed benefits of breaking up the largest banks is to reduce risk to the financial system. This line of thinking comes from the fact that some of the largest banks are a part of so many financial transactions, across so many industries, that if they go bankrupt it could cause a shock to financial system. This most famously played out when the investment bank Lehman Brothers filed for bankruptcy during the financial crisis in 2008, causing credit around the world to freeze up and sending markets into a tailspin. Obviously, this is something we would want to avoid in the future.
The idea of breaking up banks is not a new one. During the Great Depression, the Banking Act of 1933 (aka Glass-Stegall) was passed. This law contained provisions prohibiting a firm from operating both commercial banking (deposit taking) and investment banking (issuing and underwriting investment securities) operations. The goal here was to ensure that banks that took deposits were unable to risk that money through the investment operations. This law was repealed in 1999 and people say that helped to worsen the financial crisis.
I contend that size was not the issue in the financial crisis. In fact, the bigger banks are larger today than they were before the crisis because they were able to absorb some of the smaller, less well capitalized banks who would have otherwise failed in a much more dangerous fashion. So the ability of companies like Wells Fargo, JP Morgan, and Bank of America to take on failing smaller banks may have helped instead of hurt. Yes, it is true that all of these banks took taxpayer bailout money, but if there were twice as many banks that were half as big, the problem would have been the same size. The bill to the taxpayer would have been the same amount.
Bernie’s proposal is the “too big to fail, too big to exist act” and can be found here. In terms of breaking up banks, it is very lacking on details. How would they be broken up? What kind of process would banks have to go through? It actually may make good business sense for some of the banks to make themselves smaller, however, a law to force them to shrink would be messy, expensive, and could pose a risk to international competitiveness. Making our financial system weaker on a global scale would do more harm than good.
The bottom line is that it was not the biggest banks that caused the worst of the financial crisis. Size was not the issue because the problems were systemic and not isolated to specific institutions. And, by the way, the large banks mentioned above have all since paid bank the government – with interest.
It’s not to say that there is not some Wall St. culpability for what went on. And, some of these banks did in fact take far too much risk, but I don’t think “breaking up the big banks” is the best answer. I think that closer oversight under the new Dodd-Frank legislation, and living wills to map out how a failing bank can be safely unwound, are better alternatives. Any bank that is currently being classified as a Systemically Important Financial Institution (SIFI) is subject to closer scrutiny now which may incentivize some banks to shrink regardless. Breaking up the banks in a spirit of reducing risk with very thinly veiled vengeance is a sloppy solution to the problem of risk in the financial system.
I do think that Mr. Sanders has many redeeming qualities and I admire his sincerity and passion. However, I do worry about the rhetoric of lumping our entire financial system into one evil “Wall St. bankers” crowd. The biggest banks on Wall St., just like the community banks on Main St., are all important pieces of the financial system that our economy needs in order to operate. I would prefer a candidate propose to work with the leaders of these organizations to help determine the best ways to guard against future crises. But given the current state of our political environment, that may be wishful thinking.
Until next time…..
“Politics is the art of looking for trouble, finding it everywhere, diagnosing it incorrectly and applying the wrong remedies.” – Groucho Marx
photo credit: Gage Skidmore via flickr.com