Man Lands on Mars: TBTF Again
Well not exactly. But close. The feeling of exhilaration and adventure that surely would accompany such an event is exactly the feeling I experienced when I read that a session at this year’s annual American Economics Association actually discussed something relevant to the economy. Wow. That’s big.
The discussion in question was one concerning the big banks and specifically the, by now, old chestnut of ‘too big to fail’.
The reason I bring this to your attention is that Tom Hoenig, who is President of the Kansas City Federal Reserve bank, went much further than he has in the past by advocating that we break up the big banks. He is now becoming both more consistent and vocal in his advocacy. His comments to the AEA meeting were positively rebellious.
The momentum is building. With Paul Volcker still beating the ‘break them up’ drum, and with others beginning to come on board, there is now a glimmer of optimism that we may actually be able to make progress in our efforts to limit the damage the big banks can do whenever they go insane again – presuming that they are not already headed that way.
This is not a trivial issue and is one we all ought to be concerned with.
Of all the potential sources of instability in the economy big finance heads the list. It is inherently an unstable activity subject to violent swings of fashion, especially given its anti-social compensation structure which is specifically designed to channel cash from shareholders and the public into the pockets of executives and traders. I reported yesterday that this inherent instability has been thoroughly discussed by Hyman Minsky who was a more ardent Keynsian than Keynes himself. Minsky’s basic notion is that as the economy rewards bankers for extending credit – during the initial stages of a recovery – it encourages them to take on more risk. This extra risk is justified at first because the economy is robust and borrowers are well capable of repayment from the profits of their businesses. Unfortunately as growth continues this success allows borrowers to over extend themselves, and they enter what Minsky called the Ponzi finance period of growth, where money borrowed was being used to repay earlier loans because profits were not sufficient. Eventually, of course, some borrowers default and the conditions are in place for a credit crisis.
This story should sound familiar.
Minsky’s work has long been marginalized in economics because of his association with Keynes. So his analysis is not taught at any of our best universities, just as Keynsian economics is not taught. This incredible memory loss is just one aspect of the astonishing foolishness we nowadays call the economics profession. Economists are much more concerned with the study of economics than with the study of real world economies. That might sound nuanced or bizarre but it contributes to our everyday crisis. Economists are extremely ill-equipped to tackle real world situations. This is because the textbooks just don’t include much by way of real world examples. I challenge you all to look up the word ‘bank’ in the table of contents of a standard micro-economic text. It isn’t there.
Banks as business firms do not occur in economic theory. I talked about why yesterday: economists have avery peculiar view of money. In fact they ignore it as an economic factor except for its role in inflation and the separation between ‘nominal’, i.e. real world, prices and ‘real’, i.e. inflation adjusted prices.
As you imagine, therefore, it can be quite a shock to see a whole bunch of economists talking about the banking crisis as if they had any clue. To be fair there are a ton of economists who have worked in banking and therefore are quite capable of such a discussion. My point is that to gain that experience they have to ignore or unlearn what they learned of economic theory. They are flying by the seat of their pants.
Meanwhile back to Hoenig:
Breaking up the banks is the only viable policy that would guarantee a more manageable social cost in future bail outs. The social benefit of maintaining the FDIC safety net is too large for us to give it up, and, likewise, we are not likely to want our largest banks to go belly up without our having an orderly way to push them through rapid bankruptcy. The cost of economic disruption far outweighs the reduction to the so-called ‘moral hazard’ of our safety net that so vexes right wing politicians and economists.
So we are stuck. We want to keep the safety net because, in aggregate, it protects all of us. At the same time we want to lower its cost, which this time around was enormous.
The best way to accomplish these two contradictory goals is to make sure that each time a bank fails it cannot be so large we have no choice but to bail it out. We need smaller banks plus a quick bankruptcy wind up method.
Add in the re-establishment of the separation between gambling and basic banking – by bringing back some form of the New Deal era Glass-Steagall Act – and we are well on our way to getting banking back to being both boring and safe. Which is where it should be.
Will we get there?
The odds are still against it. With corruption rife in Congress, and with bank lobbyist money flowing into Senatorial pockets, the voice of the public is not easily heard. Still money talks, and the banks just blew through a wad of taxpayer money. Someone down there must have noticed. Let’s hope that offsets the natural inertia of our favorite gentleman’s club.
