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One of the more interesting counter-arguments against the idea that big banks should be broken up comes from people who play close attention to the behavior of small banks. They point out that small banks are a powerful political lobby, a point nicely illustrated by the NYT's explanation of how changes to bankruptcy law were recently derailed.
The big banks, in this view, are no more oligarchic in their tendencies than small banks.
It is definitely the case that small banks can get together and demand political favors. You need transparency and a strong open debate to offset that—and, according to leading congressional figures, you also need the Obama administration to show up, help out, and resist capture:
"Moreover, Timothy F. Geithner, the Treasury secretary, did not seem to share Mr. Obama's enthusiasm for the bankruptcy change.
Mr. Geithner was lobbied by the industry early. Two days after he was sworn in, he invited Mr. Fine from the community bankers to his office for a private meeting. The association, with influential members in every Congressional district, is one of Washington's most powerful trade groups."
The more interesting question is whether many small banks could copy each other's behavior and create a situation where they are all "too big to fail" at more or less the same moment. Some call this lemming behavior, but that may be unfair on the little critters.
Surely this is very hard to pull off in practice. In his Logic of Collective Action, published in 1965, Mancur Olson argued that it's hard for large groups to cooperate effectively, particularly when there's an incentive to "free ride."
What would free riding mean in this context, which is somewhat different from the public goods provision issue that Olson focused on? Probably it would mean pretending that you're just like the rest of the pack, but quietly hanging back as the pack heads towards the next subprime-type cliff—and then buying up everything you want from the wreckage.
Then you get to run ads like JP Morgan currently has over at the Atlantic—in a nice, but surely coincidental irony, this currently shows above the top of The Quiet Coup. And, less likely to coincidental, the JP Morgan campaign has almost the same name as the main "constrain the big banks" movement: A New Way Forward. (Presumably, Jamie Dimon, head of JP Morgan, couldn't persuade McDonald's to part with the relevant rights to I'm Lovin' It.)
The failure of big banks endangers financial systems and their rescue—as organized by the Bush and Obama administrations—results in a massive increase in the public debt. The failure of small banks is an issue in some countries, but in the United States, the FDIC takes them over for breakfast—here's how they spent Friday.
Lemmings of the world, watch out for Jamie Dimon.
Global Crisis and Reform: Starting a Long Journey
I spoke Friday afternoon to MIT Sloan graduates (Reunion Weekend; slides attached ), arguing that while we are likely done with a panic or "free fall" phase, we have only just begun to deal with the deeper problems revealed by the global financial crisis.
Think of it this way. The United States has done well over the past 200 years or so because it was founded with strong institutions, rules and laws that mean we're protected from government or elites becoming too powerful, and over time these have generally improved, or at least not collapsed under pressure. Yes, you can complain about (and aim to improve) many aspects of our society, but where would you prefer to set up a technology-based business or make any kind of productive investment or build your own human capital?
Call this the rule of law, or protection against being expropriated, or sufficient constraints on executive power, but it adds up to roughly the same thing: We strongly limited the power of the most powerful in our society, and this is in striking contrast to what happens in much of the rest of the world.
But over the past 20–30 years, we took our eye off this ball.
The financial sector, under our noses, amassed enormous economic clout and mystique and leveraged (pun intended) this into tremendous political power, both in terms of the belief that Wall Street can do no wrong, and that we should defer to financial "experts" both on the way up and during the crash (despite the fact that their interests are not necessarily our interests).
Our institutions have been undermined by powerful people. We've seen this before, of course, both around the world and also in the United States. It's Andrew Jackson vs. the Second Bank of the United States, or Teddy Roosevelt against the great railroad trusts and big oil, or the Pecora Hearings on the financial shenanigans that helped bring on the Great Depression.
Disproportionate power does not prevent economic growth; there are plenty of booms in banana republics. But "banana booms" never prove sustainable. You get reasonable rates of growth, perhaps even for a decade or more, but then a collapse. Weak institutions are strongly associated with instability, crises, and lost decades. In fact, a lot of what we think of as decisive macroeconomic policy , which the IMF, for example, traditionally focuses on, turns out to matter much less than how much you undermined sensible rules and norms during the boom.
When the crisis hits, you see the problems with glaring clarity: the political connections, the excessive and irresponsible behavior of financial elites, and the extent to which the executive has been captured by whatever branch of oligarchy was boosted by the boom.
The crisis per se does not weaken the powerful. Sure, a few of them may go bankrupt, but this just further increases the concentration of economic power or, if you prefer, their market share. It is for good reason that Jamie Dimon, ever the master of CEO semiotics, said to his shareholders recently: 2008 "might have been our finest year ever."
Most countries are doomed to this oligarchy-boom-bust-oligarchy cycle. The United States broke free or at least temporarily broke away from versions of this cycle, arguably, three times already (Jackson, Roosevelt I, Roosevelt II). Each time the reform process took 5–10 years, perhaps longer from start to finish.
Can we do it a fourth time and how long will that take?
Also posted on Simon Johnson's blog, Baseline Scenario
