A Poorly Constructed Defense of Big Banks

In yesterday’s New York Times opinion page, William B. Harrison, Jr. penned an impassioned defense of the big, consolidated banks against those who worry about the financial instability in the current system. Harrison’s article presents a poorly constructed argument, rife with claims that only further the case for returning to the regulatory regime of Glass-Steagall.

The first fallacy is that the emergence of large, universal banks — combining commercial banking with investment banking — was an artificial or unnatural development. In 1990, there were 15,000 banks in the United States; this fragmented market meant that banks could not achieve economies of scale or easily serve clients on a national or global level.

Is Harrison seriously arguing that the United States was not the global banking leader until 1990? Because that’s just false. Prior to 1990, the banking sector continued to serve large and international clients effectively, often by joining together to finance deals. Harrison is unable to identify any investments made since 1990 that were impossible for financial institutions before the banks merged.

A second fallacy is that these large, universal institutions were primarily to blame for the financial crisis. As most serious observers acknowledge, a combination of bad lending and risk management by banks, poor regulation and ill-advised consumer behavior all played a role. None of the first institutions to fail during the crisis — Countrywide, Bear Stearns, IndyMac, Fannie Mae and Freddie Mac, Merrill Lynch, Lehman Brothers, the American International Group — were universal banks.

This is a circular argument — the big banks, with the most money, didn’t collapse in the first wave of banking failures. But the big banks had more money on hand — obviously they would not go under in the first wave. But it certainly doesn’t suggest that the big financial institutions had no role in the crisis. “A combination of bad lending and risk management by banks, poor regulation and ill-advised consumer behavior all played a role.” This doesn’t actually answer the issue. Harrison admits that banks are responsible for large swaths of the crisis and has no explanation for how making these banks more powerful didn’t exponentially increase the scope of the crisis, which spread globally as every tentacle of these banks around the world suffered from their policies. Here’s a great guide to the crisis:

Harrison also brings the canard of “ill-advised consumer behavior.” Like a bully saying, “stop hitting yourself,” the financial sector keeps trying to sell us the myth that up-selling consumers with more and more favorable mortgage terms instead of declining to loan is somehow the fault of the consumer. If banks really had no choice but to open their vaults and hand out money to any consumer who asks, financial institutions have a bigger problem.

A third fallacy is that large financial institutions have become too complex to manage. A company of any size needs robust management and controls to manage complexity. Remember that smaller financial institutions — look at MF Global, Bear Stearns, Knight Capital — have had their share of risk-management failures too.

Small firms also fail…so therefore big banks are good? Firms fail for a variety of reasons, but MF Global was a contained loss while a screw up by Citigroup can lose billions in seconds. The threat to the fabric of the economy is much more pronounced when the sector is dominated by a few big banks. Remember how we needed to spend billions in taxpayer funds to prevent the entire economy from collapsing because the big banks spread their toxic screwups throughout the market?
Other criticisms of big banks that are often aired similarly don’t stand up to scrutiny. Commentators point to the inordinate influence large banks have on the political process. They fear that regulators are cowed by a large bank’s position and power. These critics seem to believe that regulators are incapable of making independent judgments. In the real world, this is just false. That said, it is perfectly appropriate and indeed necessary for regulators and politicians to engage with experts and industry practitioners to learn more about the issues. Regulators are not cowed, but they generally do need more expertise and better collaboration with one another to carry out their responsibilities successfully.
Translation: Regulators aren’t beholden to the big banks, but we need a system that makes them more in line with the wishes of big banks. You can’t make this up.
Harrison never once addresses the banking bailout or the continuing fallout of the Merrill Lynch acquisition of Bank of America. The “boom-bust” (with the bust component paid for by taxpayers) mentality of conservative economic thought guides Harrison’s entire article — focus on how the big banks can make bigger profits and ignore the flipside that big banks can create bigger losses too.

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