If We Don't Break Up the Giant Banks NOW, They'll Be Bailed Out Again and Again … Dragging the World Economy Down With Them


I warned last year:

Anyone   who thinks that Congress will use the current financial regulation –    Dodd-Frank – to break up banks in the middle of an even bigger crisis  is  dreaming.   If the giant  banks aren’t broken up now – when they are threatening to take down the  world economy – they won’t be broken up next time they become insolvent either.   And see this.  In other words, there is no better time than today to break them up.

Standard and Poors is providing evidence for this assertion.

As the Financial Times notes today:

Officials fighting the next financial crisis may again bail out banks using the public purse, S&P has said, in an opinion that casts doubt on one of the fundamental tenets of US financial reform.

The rating agency said on Wednesday that the US Treasury, Federal  Reserve and Congress might rescue a large financial group rather than  allow it to fail like Lehman Brothers. Dodd-Frank, the legislation  signed into law a year ago next week, was supposed to prevent bail-outs  by allowing the government to seize and wind down safely an ailing “systemically important financial institution”, or Sifi.

But  in a research note, S&P said: “We believe the government may try to  avoid contagion and a domino effect if a Sifi finds itself in a  financially weakened position in a future crisis.”The agencies’ views are crucial to the fight over whether the  phenomenon of “too big to fail” has been ended. If not, the largest  banks will continue to enjoy a funding advantage over their smaller  rivals.


And see this (written after the passage of Dodd-Frank).

Why Break Up the Giant Banks?

Virtually all independent economists and financial experts say that the giant banks are too big, and that their very size is hurting the economy:

  • Dean     and professor of finance and economics at Columbia Business School,    and  chairman of the Council of Economic Advisers under President  George   W.  Bush, R. Glenn Hubbard
  • President of the Federal Reserve Bank of St. Louis,  Thomas Bullard
  • Former Tarp overseer and creator of the Consumer Financial Protection Bureau, Elizabeth Warren
  • The leading monetary economist and co-author with Milton Friedman of the leading treatise on the Great Depression, Anna Schwartz
  • Economics professor and creator of the “efficient market hypothesis”, Eugene Fama
  • Economics professor and senior regulator during the S & L crisis, William K. Black
  • Professor of entrepreneurship and finance at the Chicago Booth School of Business, Luigi Zingales

Why do these experts say the giant banks need to be broken up?

Well, small banks have been lending much more than the big boys.  The giant banks which received taxpayer bailouts have been harming the economy by slashing lending, giving higher bonuses, and operating at higher costs than banks which didn’t get bailed out.

As Fortune pointed out, the only reason that smaller banks haven’t been able to expand and thrive is that the too-big-to-fails have decreased competition:

Growth    for the nation’s smaller banks represents a reversal of trends from   the  last twenty years, when the biggest banks got much bigger and many   of  the smallest players were gobbled up or driven under…

As  big   banks struggle to find a way forward and rising loan losses  threaten  to  punish poorly run banks of all sizes, smaller but well  capitalized   institutions have a long-awaited chance to expand.

So the very size of the giants squashes competition, and prevents the small and medium size banks to start lending to Main Street again.

And as I noted in December 2008, the big banks are the major reason why sovereign debt has become a crisis:

The   Bank for International Settlements (BIS) is often called the “central   banks’ central bank”, as it coordinates transactions between central   banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto   government balance sheets, which is reflected in the corresponding   widening of sovereign credit default swaps:

The   scope and magnitude of the bank rescue packages also meant that   significant risks had been transferred onto government balance sheets.   This was particularly apparent in the market for CDS referencing   sovereigns involved either in large individual bank rescues or in   broad-based support packages for the financial sector, including the   United States. While such CDS were thinly traded prior to the announced   rescue packages, spreads widened suddenly on increased demand for  credit  protection, while corresponding financial sector spreads  tightened.

In  other words, by assuming huge portions of  the risk from banks trading  in toxic derivatives, and by spending  trillions that they don’t have,  central banks have put their countries  at risk from default.

A study of 124 banking crises by the International Monetary Fund found that propping banks which are only pretending to be solvent hurts the economy:

Existing  empirical research has shown that providing assistance to banks  and  their borrowers can be counterproductive, resulting in increased  losses  to banks, which often abuse forbearance to take unproductive  risks at government expense. The typical result of forbearance is a  deeper hole in the net worth of banks, crippling tax burdens to finance  bank bailouts, and even more severe credit supply contraction and  economic decline than would have occurred in the absence of forbearance.

Cross-country   analysis to date also shows that accommodative policy  measures (such   as substantial liquidity support, explicit government  guarantee on   financial institutions’ liabilities and forbearance from  prudential   regulations) tend to be fiscally costly and that these  particular policies do not necessarily accelerate the speed of economic  recovery.


All too often, central banks privilege stability over cost  in the heat of the containment phase: if so, they may too liberally  extend loans to an illiquid bank which is almost certain to prove  insolvent anyway.   Also, closure of a nonviable bank is often delayed for  too long, even   when there are clear signs of insolvency (Lindgren,  2003). Since bank   closures face many obstacles, there is a tendency to  rely instead on   blanket government guarantees which, if the government’s  fiscal and   political position makes them credible, can work albeit at  the cost of placing the burden on the budget, typically squeezing future  provision of needed public services.

Now,  Greece, Ireland, Portugal, Spain, Italy and many other European countries – as well as  the U.S. and Japan – are facing serious debt crises. We are no longer  wealthy enough to keep bailing out the bloated banks.

Indeed, the top independent experts say that the biggest banks are insolvent (see this, for example), as they have been many times before. By failing to break up the giant banks, the government will keep taking emergency measures (see this and this) to try to cover up their insolvency.  But those measures drain the life blood out of the real economy.

And by failing to break them up, the government is guaranteeing that they will take crazily risky bets again and again, and the government will wrack up more and more debt bailing them out in the future.

Moreover, Richard Alford – former New York Fed economist, trading floor economist and strategist – recently showed that banks that get too big benefit from “information asymmetry” which disrupts the free market.

Indeed, Nobel prize-winning economist Joseph Stiglitz has noted that giants like Goldman are using their size to manipulate the market:

“The    main problem that Goldman raises is a question of size: ‘too big to    fail.’ In some markets, they have a significant fraction of trades. Why    is that important? They trade both on their proprietary desk and on    behalf of customers. When you do that and you have a significant    fraction of all trades, you have a lot of information.”

Further,    he says, “That raises the potential of conflicts of interest, problems    of front-running, using that inside information for your proprietary    desk. And that’s why the Volcker report came out and said that we need    to restrict the kinds of activity that these large institutions have.  If   you’re going to trade on behalf of others, if you’re going to be a    commercial bank, you can’t engage in certain kinds of risk-taking    behavior.”

The giants (especially Goldman Sachs) have also used high-frequency program trading  which not only distorts the markets – making up more than 70% of stock trades – but which also lets the    program trading giants take a sneak peak at what the real (that is,    human)  traders are buying and selling, and then trade on the insider    information. See this, this, this, this and this. (This is  frontrunning,    which is illegal; but it is a lot bigger than garden variety    frontrunning, because the program traders are not only trading based on    inside knowledge of what their own clients are doing, they are also trading based on knowledge of what all other traders are doing).  Goldman also admitted that its proprietary trading program can “manipulate the markets in  unfair ways”.

Moreover, JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley together hold 80% of the country’s derivatives risk, and 96% of the exposure to credit derivatives. Experts say that derivatives will never be reined in until the mega-banks are broken up – and see this – even though the lack of transparency in derivatives is one of the main risks to the economy.

The giant banks have also allegedly used  their Counterparty Risk Management Policy Group (CRMPG) to exchange secret information and formulate coordinated  mutually beneficial actions, all with the government’s blessings.

Again, size matters.  If a bunch of small banks did this,  manipulation   by numerous small players would tend to cancel each other  out.  But  with  a handful of giants doing it, it can manipulate the  entire economy  in  ways which are not good for the American citizen.

Further, fraud was one of the main causes of the Great Depression and the current financial crisis.  The banks are so big that they are buying off politicians so that it has become official policy not to prosecute fraud.   Indeed, everyone from Paul Krugman to Simon Johnson has said that the banks are so big and politically powerful that they have bought the politicians and captured the regulators. So their very size is allowing economy-killing corruption to flourish.

Moreover, the banks’ enormous size means that the executives make orders of magnitude more in bonuses and salary than the executives of small banks.  They are so big that their executives are living like kings.  This is making inequality worse … and rampant inequality was another primary cause of the Great Depression and the current financial crisis.

Indeed, failing to break up the big banks will result in the sale of national assets and the looting of national treasuries in order to pay off debts to the giant banks.  This, in turn, will destroy the national sovereignty of virtually every country.

Leading independent bank analyst Christopher  Whalen argues:

The  fraud and obfuscation now  underway in  Washington to protect the    TBTF  [i.e. giant or “too big  to fail”] banks … totals into the   trillions of dollars and rises to     the level of treason.

Just look at Greece.  That is our future – and see this – unless we break up the “too big to fails”.

These concepts have been known for hundreds of years:

“When a government is dependent upon bankers for money, they and not   the leaders of the government control the situation, since the hand that   gives is above the hand that takes… Money has no motherland;   financiers are without patriotism and without decency; their sole object   is gain.”
– Napoleon Bonaparte

“There are two ways to conquer and enslave a nation. One is by the sword. The other is by debt.”
– John Adams

“If   the American people ever allow the banks to control issuance of their   currency, first by inflation and then by deflation, the banks and   corporations that grow up around them will deprive the people of all   property until their children will wake up homeless on the continent   their fathers occupied”.
— Thomas Jefferson

“I  believe that   banking institutions are more dangerous to our liberties  than standing   armies…The issuing power should be taken from the banks  and restored   to the Government, to whom it properly belongs.”
– Thomas Jefferson

“[It was] the poverty caused by the bad influence of the English     bankers on the Parliament which has caused in the colonies hatred of the     English and . . . the Revolutionary War.”
– Benjamin Franklin

“The   Founding Fathers of this great land had no difficulty whatsoever    understanding the agenda of bankers, and they frequently referred to    them and their kind as, quote, ‘friends of paper money. They hated the    Bank of England, in particular, and felt that even were we successful  in   winning our independence from England and King George, we could  never   truly be a nation of freemen, unless we had an honest money  system. ”
-Peter Kershaw, author of the 1994 booklet “Economic Solutions”

“[T]he   creation and circulation of bills of credit by revolutionary    assemblies…coming as they did upon the heels of the strenuous efforts    made by the Crown to suppress paper money in America [were] acts of    defiance so contemptuous and insulting to the Crown that forgiveness was    thereafter impossible . . . [T]here was but one course for the crown   to  pursue and that was to suppress and punish these acts of    rebellion…Thus the Bills of Credit of this era, which ignorance and    prejudice have attempted to belittle into the mere instruments of a    reckless financial policy were really the standards of the Revolution.     they were more than this: they were the Revolution itself!”
– Historian Alexander Del Mar

“The   British Parliament took away from America its  representative money,   forbade any further issue of bills of credit,  these bills ceasing to be   legal tender, and ordered that all taxes  should be paid in coins …   Ruin took place in these once flourishing  Colonies . . . discontent   became desperation, and reached a point . . .  when human nature rises  up  and asserts itself.”
– British historian John Twells