Gene Fama

Before they break us up. Again.

I have stayed away from discussing the banks in recent months largely because I consider the solution to our banking problems to be self evident. They’re too big. Make them smaller. Arcane debates over capital ratios, naked CDS prohibitions and other bureaucratic responses are all small fry and akin to re-arranging deck chairs. The chairs are just fine. It’s the Titanic we need to worry about.

For instance, I look at the current Euro crisis through the prism of banking. The Europeans have allowed their banks to grow so large that they fear for their economies were one or more of those behemoths to collapse under the weight of toxic sovereign debt. So, central to the overall Euro crisis, is bank stability. Indeed that is the most pressing issue even if the inept leaders of various European nations don’t care to admit it.

With that said I will re-state my position: despite the reams of paper dedicated to bank reform here since the crisis began we have not taken strong or sufficient action to prevent a repeat. We are still susceptible to a banking crisis. Perhaps even more so given that the largest banks are all now much larger than they were when the original crisis erupted. The banks still are being heavily subsidized. There are insufficient incentives on the banks to limit their activities. And, they still exert undue influence on our political process. In short they remain anti-social and not focused on those aspects of their business that adds value to society at large.

There’s just no polite way to say this: the banks are nasty. They can do immense damage far, far, out of proportion to any value they represent. We need to do radical surgery not a facelift.

Since I have heard little substantive discussion of possible action to break up the banks into more manageable chunks – by which I mean pieces small enough to allow to fail – I have ignored banking regulatory discussions generally.

That changed today.

Jon Huntsman, the most marginal of a host of marginal Republican candidates for President, has written an op-ed for the Wall Street Journal arguing that the banks are too big.

It makes sense that a right winger would take up the challenge, though Huntsman is hardly a extremist. Smaller banks would not live off the largesse of taxpayer subsidy the way are largest banks currently do. I would have thought that any right winger worth their salt would want to reduce subsidies. The implicit guarantees of “too big to fail” are a humdinger of a subsidy. So cutting the big banks down in size should be a top agenda item for any red blooded capitalist. Forgive me if I am wrong, but I imagine any Austrian or classical economist, Ayn Rand fan, or sundry libertarian would salivate at the prospect of cutting our big banks down, fostering true competition, and letting the devil take the hindmost. Even Gene Fama, whose laughableEfficient Markets Hypothesis I hold in utter contempt, is on board with our cutting the big banks down in size. It is a strange day indeed when I agree with a hard core University of Chicago person.

Huntsman is right when he argues the Dodd-Frank resolution authority method for eliminating “too big to fail” is a skimpy fig leaf at best. No right minded politician would allow one of our big banks to collapse, so the guarantee remains in force no matter what Dodd-Frank says. In the next crisis – which we will assuredly get one day – we will be treated to a repeat of the Lehmann/Bear Stearns mess where frightened politicians run around trying to shore up goliath organizations each of which is capable of destroying the economy. All the innocent sworn forbearance in the world will vaporize the instant one of the dinosaurs of Wall Street starts to implode. We simply cannot afford the disruption, uncertainty, and outright panic that would ensue. Smaller banks we close and lose every day. Big banks are too large to swallow so easily.

Surely we learned this.

Apparently not.

Our weak kneed politicians gave in to the assault of bank bought lobbyists and avoided the issue of size. Instead they produced the reams of Dodd-Frank. Full of nice details. Beautifully crafted. And demolished whenever a big bank crumbles.

In the annuls of our cautious response to the crisis the bank reform effort stands out as one of the least bold, ineffectual, and industry bought. And the competition for that title is stiff.

The greatest obstacle to progress, by which I mean getting smaller banks, has been the inordinate political clout they can muster to defend their privileges. So it is pleasant, to say the least, to see a Republican entering the fray. In the Wall Street Journal, no less.

Perhaps there’s hope.

Break up the banks!