Why I Think Big Banks Are Bad

Just to be clear.

Big banks are contaminated by complexity. They are too to understand. Thus they are inherently even more unstable than smaller banks. And that’s saying a lot. The economics goes like this:

Large bureaucracies like banks are networks. Those networks shuttle information around and are designed to manage tasks. Each task contains a series of steps, which, in turn, can act as nodes on different networks. A coherent set of tasks constitutes a ‘process’. Tasks come in two basic varieties: ‘roles’ and ‘routines’. Roles are tasks that face less certain and less frequent events. They thus require more ad hoc decision making and are the centers of innovation. Routines are tasks that face frequent and certain events. They can thus be automated, or they require fixed, known skills. They tend to be repetitive and are not sources of innovation.

It is well known that large networks, with many interconnected nodes, can reach a dysfunctional size: the channels for information transmission choke and become incapable of carrying the load. Once this happens the entire network fails to channel information through to the proper decision making locus, and inefficient responses to events begin to become the norm. Different parts of the organization become cut off from one another, and the network starts to fragment.

Such a network rapidly fails. It has become overly complex.

In business it is normal to reduce network dysfunctionality by imposing strict hierarchical information flows: the classic ‘command and control’ structure of most companies. But even this attempt at efficiency will fail if the span of control grows too large: a greater span adds more nodes into the network. Eventually the width of the network introduces sufficient complexity that it grinds to a halt.

Large banks exhibit all the hallmarks of such failure.

Reducing bank size allows better decisions to be made about risk and the other key attributes of sound banking.

But.

My biggest objection to large banks isn’t this argument about efficient decision networks. It is an argument based on politics.

Big banks have sufficient clout to bend the rules. The Bush era revision of the bankruptcy code is a good example of this clout. The banks wrote the law. Literally. Congress merely enacted it. The banking industry wields immense financial power. This is especially true in the American political system where cash floods the process and corruption is rife. Large banks have the ability to lobby beyond the industry groups. They spend vast amounts of money to buy contacts and influence. They expect a return on that expenditure.

In a political system that is endemically corrupt due to the cash flowing through it – and I mean corruption in the sense that cash distorts the legislative agenda – deep pockets are dangerous and anti-social. They are a threat to democracy.

That alone is sufficient cause to break the banks into smaller chunks.

Big banks are not just inefficient bureaucracies prone to wrongheaded or misinformed decision making – witness CDO’s, they are potential sources of corruption.

Hence they are bad.