By Simon Johnson. This material was prepared as part of the New York Times' Room for Debate on "Should Mega-Banks Be Broken Apart"? I strongly recommend the post by Anat Admati.
Writing in the Washington Post, in November 2009, Jamie Dimon, chief executive of JP Morgan Chase, argued:
"Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank's shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets. Those who benefited from mismanaging risks or taking on inappropriate risk should feel the pain."
But the Dodd-Frank financial reform legislation does not create a "resolution mechanism" that can deal with cross-border megabanks; this point is admitted by all involved. And there is nothing in the G20 process or underway with any other international forum that would make a difference in this regard.
So when very big banks are on the brink of failure, the Obama administration and Congress will have to face this choice: either let this big bank go through bankruptcy, like Lehman Brothers, or provide it with a bailout — meaning complete protection for all creditors (but hope you can at least remove some management this time around).
Unfortunately, the Irish experience shows that the "let's do an unsavory bailout" will like not end well next time. Our megabanks are getting bigger — as we demonstrated in 13 Bankers and as Thomas Hoenig argued in the Times last week — not because of any kind of legitimate market process, but because they benefit from an unfair and non-transparent government subsidy. And these big banks have recklessly dangerous levels of debt relative to equity, as Anat Admati and her colleagues have pointed out.
Put simply, by allowing our biggest banks to become even bigger — and more leveraged — the government is taking on a large contingent fiscal liability. Whatever you think of current fiscal policy — and whatever the outcome of the current debate over taxes and spending in the U.S. — remember this: by all standard balance sheet measures, Ireland was running responsible fiscal policy over the past decade. But the implicit liabilities of the Irish state were ballooning out of control, in direct proportion to the size of the biggest Irish banks. Three banks failed and this has taken down the entire Irish economy.
There are no economies of scale or scope in banking over about $100 billion in assets. Bankers, like Jamie Dimon, make claims to the contrary — including in an interview published in the New York Times on Sunday. But they do not have a single piece of evidence that society gains from having megabanks at today's scale and with today's leverage.
Our biggest banks are already subject to a partial size cap. According to the Riegle-Neal Act of 1994, no one bank can have more than 10 percent of total retail deposits in the United States. Unfortunately, the growth of wholesale financing and the global spread of these banks essentially made a mockery of this sensible macroprudential regulation.
We should update and apply the Riegle-Neal Act, exactly as proposed by Senators Sherrod Brown and Ted Kaufman in spring 2010.
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