Simon Johnson deserves tons of kudos for pointing out that the US is in the hands of financial oligarchs, via his celebrated Atlantic article, “The Quiet Coup.” But having recognized a clear and present danger, he seems peculiarly willing to confuse non-solutions with meaningful measures. In an article at Project Syndicate, he incorrectly celebrates a toothless provision in the Dodd-Frank bill as being tantamount to an anti-trust act for too big to fail banks:
Now, however, a new form of antitrust arrives – in the form of the Kanjorski Amendment, whose language was embedded in the Dodd-Frank bill. Once the bill becomes law, federal regulators will have the right and the responsibility to limit the scope of big banks and, as necessary, break them up when they pose a “grave risk” to financial stability.
This is not a theoretical possibility – such risks manifested themselves quite clearly in late 2008 and into early 2009. It remains uncertain, of course, whether the regulators would actually take such steps. But, as Representative Paul Kanjorski, the main force behind the provision, recently put it, “The key lesson of the last decade is that financial regulators must use their powers, rather than coddle industry interests.”
And Kanjorski probably is right that not much would be required. “If just one regulator uses these extraordinary powers [to break up too-big-to-fail banks] just once,” he says, “it will send a powerful message,” one that would “significantly reform how all financial services firms behave forever more.”
Yves here. Citbank, JP Morgan, Bank of America, Wells, Goldman, and Morgan Stanley NOW constitute “a grave risk to financial stability.” You could extend the list further into the stress test banks (19 in the US), but let’s stick with these. If we believed this bill was meaningful, action be taken against these banks immediately upon signing. Odds of that happening? Zero.
And there is good reason why. Breaking up banks is not a way to solve the TBTF problem. The Kanjorski amendment is a lame-brained remedy.
The problem is it not merely the size of these firms, but the fact that they control infrastructure that is deemed critical to modern commerce. I’ll get into specifics in short order, but in some cases the firm owns critical plumbing outright; in other cases, it is so tightly networked to other firms that mucking with it very much runs the risk of taking down the rest of the grid. As Richard Bookstaber pointed out in his book Demon of our Own Design, in a tightly coupled system, efforts to mitigate risk typically make matters worse. You need to reduce the degree of integration first, then more direct efforts to lower risk are less likely to produce unexpected perturbations.
It is also critical to understand that making firms smaller does not necessarily make them less “TBTF”. So if an alternative universe variant of the Obama Administration were to decide it was going to bolster its poll ratings by roughing up financiers, one course of action would be to break up a large bank. But the businesses that are easiest to hive off – asset management and retail banking – pose no systemic risk. If the bank were BofA, the next step would be to split Merrill back out. But Merrill on its own represented a systemic threat, remember?
Let us look at Citibank. Why has it been allowed to lurch from crisis to crisis? One big reason is it has simply oodles of uninsured foreign deposits, roughly $500 billion during the crisis. Mess with Citi, and you have the prospects of bank runs all over the world. Moreover, these very large foreign deposits in large measure result from the fact that Citi runs a big corporate cash management/reporting system called GTS.
Now I don’t buy that GTS could not be separated from Citi, although operational it would be a huge pain. But Citi will howl like a stuck pig because this is a bread and butter business, almost certainly low margin, but keeps its foot very firmly in the client’s door and gives it an excellent overview of its businesses. The intelligence it derives from that wide perspective no doubt gives Citi an advantage in selling more complex products (note the big value added is likely in the information, not the access it gives, since the day to day contact for this is likely the assistant Treasurer, generally not an influential player).
But the authorities already buy Citi’s claim, replayed in the Wall Street Journal, that GTS is too important and too integrated into the bank for it to be tampered with:
Executives told officials with the Treasury Department and the Fed that GTS’s technology and presence in more than 100 countries made it too dangerous for the U.S. to let Citigroup collapse. The Treasury gave the bank a second big helping of $20 billion just six weeks after an initial $25 billion infusion from the Troubled Asset Relief Program, partly in recognition of GTS’s importance to the financial system, according to government and company officials….
While Citigroup is primarily known for its retail banking and credit-card businesses, the GTS unit is increasingly integral to the parent company’s functioning. Clients that move funds through GTS leave a lot of cash on deposit at the unit, which funnels the money to other parts of Citigroup for lending or other uses. GTS’s deposit-gathering muscle has grown more important since the financial crisis began, now providing about 40% of Citigroup’s $800 billion of deposits.
Yves here. Or look at JP Morgan. Chris Whalen has described it as a $1.3 trillion bank attached to a $76 trillion clearing operation. Guess where the big risk sits? And the reform bill is only going to nudge some derivatives over to central clearing (the latest estimate I recall seeing is 20%). And no one is going to dare tamper with JP Morgan’s clearing business.
And what about global capital markets? The major dealers, which are the firms listed earlier, plus players like Barclays, HSBC, Paribas, Credit Suisse, Deutsche Bank, all have large counterparty exposures to each other through a whole range of businesses, from OTC derivatives to repo to more mundane credit operations. There have been initiatives to reduce the connectedness of the major players, but they seem unlikely to have much impact. As we noted, for instance, the Fed already has doubts about repo market proposals, noting that they could increase the odds of a run. Lovely.
The problem is that it would take a radical restructuring of the very biggest banks, the critically placed dealer firms, and the most important payment and clearing operations to make a real dent in systemic risk. The officialdom the political lacked the will to do so at the peak of the crisis, and there is no basis for fantasizing that it will suddenly develop more nerve now.