Break up the banks. Please.
from Peter Radford
How do I say this delicately?
The banking system, and in particular the biggest banks, were central players in the development of the crisis; they then played a major role in spreading contagion around the world; they then collapsed due to mismanagement, poor regulation, and endemic greed; this required that they be propped up beyond their normal subsidy by the taxpayer; the cost of propping them up transformed a private debt catastrophe into a sovereign debt catastrophe; this undermined national budget across the globe; which, in turn, induced a wave of austerity-driven debt reduction by governments; which has now ensured that the crisis has become a depression.
Well done banks.
Break up the banks.
So what began as an orgy of private debt growth has ended up becoming a national and governmental debt crisis. The human cost is scarcely calculable. As governments desperately try to carve back their debt levels – rightly or wrongly – they slash at programs that generally benefit the poor, the elderly, or the sick. So those that most need protection get less. Whereas the banks, sitting at the supposed center of our primal capitalist system, get coddled, protected, propped up, and generally avoid any consequence of the competitive struggle that is supposed to be that system’s hallmark feature and source of strength.
The self described paragons of capitalist virtue, those big bad bullies of cut throat trading and macho creative destruction, turn out to be mommy’s boys who cry at the slightest scratch, slink off pathetically to whimper in corners when criticized even slightly, and require a gossamer weight touch rather than a heavy hand so as to avoid their tender egos being undermined.
Meanwhile, it turns out, they’ve been cheating, conniving, and variously being rotten throughout. Indeed they represent the very apotheosis of the capitalism they espouse. Were it not for rigging, creating cabals, hiding in dark corners of murky pools, drawing a veil over their shady dealings, and corrupting public officials with floods of money, they would not have survived this long.
Our banking system is rotten to the core. It is toxic. It fails in its social purpose at every turn. It misallocates capital. Worse: it syphons off capital for its own use and thus starves the real economy. It imposes huge costs on the rest of us by way of absurd fees, poor service, and constant error in risk management. It needs perpetual attention and subsidy. In short it is a great big expensive spoiled brat.
And by big, I mean big. As in massively over-sized, flabby, gorged, and mortiferously obese.
And that’s the good news.
Please recall that, at the onset of crisis, I was one of those who argued for nationalization rather than bail out. I also called for enforced downsizing so that the banking system could be rendered into something vaguely resembling a competitive capitalist style system freed of constant public subsidy. I didn’t get very far. Such things were all too radical.
Yet here we are after years of discussion, so-called reform, and botched regulation and we are still uncovering evidence of just how deviant our banks are. To say they behave in anti-social ways is to do massive injustice to that concept. They are the very poster children of anti-social behavior.
It was inevitable.
When the American banking system was deregulated few of us predicted the current outcome. Some of that early deregulation made sense. Getting rid of the McFadden Act was sensible. Allowing banks to set up branches across state lines eliminated a very artificial and unnecessary barrier to banking business. After all the bank’s customers are not thus limited.
But getting rid of Glass-Steagall turns out to have been a big mistake.
At the time some of us were concerned about mixing trading, investment, and commercial banking under one roof. That’s a volatile mix. The prevailing theory was that the brew would be positive not negative and that the income flowing in from investment banking and trading would augment the commercial banks to keep them afloat. Recall that the big concern back then was that straightforward commercial banking was becoming increasingly unprofitable as chunk after chunk of its usual business, and thus sources of profit, were being allowed to drop outside the usual boundaries of banking. I can remember management discussions as we fretted over the damage that the boom in commercial paper issuance by AAA rated companies was doing. As more and more companies were able to raise cash outside of the then ‘normal’ channels of commercial lending the commercial banks found themselves being squeezed. They were being forced to rely on small business and individual lending, both of which were fragmented, higher risk, and lower profit.
How innocent those concerns now appear in light of the subsequent tsunami of error and failure that engulfed banking.
So the commercial banks, we were one of them, lobbied hard to be allowed to diversify. They saw trading and investment banking as alternative profit sources.
What none of us foresaw was the enormous cultural impact that the shift would have. It was assumed, as much by the regulators as by the commercial banks themselves, that the consolidation of banking would benefit the commercial banks. By size they dominated the overall industry. They would, it was thought, remain predominantly commercial, but that they would add other activities.
It didn’t work out that way. Not at all.
Because trading and investment banking produces gaudy returns on capital and because banks are rated on their ability to produce a return on capital, boards of directors, shareholders, rating agencies, analysts, and pretty much anyone involved in the development of the industry suddenly shifted their attitudes. Investment bankers producing huge profits emerged as front runners to manage the merged business. Commercial bankers, whose businesses tended to produce lower returns, fell by the wayside. Anyone with ambition went into the investment or trading side of the newly merged banks. Power went with them. The center of gravity shifted. From the late 1980′s through to today old time commercial bankers struggled to rise to the top of the industry. The top jobs invariably went to their investment banker competitors. The industry was changed beyond recognition. The older values went out the window. They were replaced by the values we are so appalled by today.
In retrospect it makes sense. In an industry obsessed by ROC, those who can claim to produce higher ROC’s win the big jobs.
Further, deregulation set off a merger mania.
When I first entered banking the bank I worked for had $2.3 billion in assets and was ranked in the top twenty-five banks in the country. JP Morgan Chase has just lost that much in one quarter on one set of trades. Those smaller banks were losing ground to non-bank competition. This meant that the regulatory system, designed to protect old time banking and thus the flow of capital into business, was becoming anachronistic. The investment banks and their ‘innovation’ were destroying the status quo. In the face of an out-of-date regulatory system the banks needed to fight back. One way – before the elimination of Glass-Steagall – was simply to create bigger commercial banks. Customers were supposed to benefit. Indeed, had this been the only trend, they probably would have. The last great innovation in banking is generally argued to have been the ATM, but I think we ought give that nod to the general ‘digitization’ of the payment system which has made electronic funds transfer, payment, and access to money more convenient and, despite those fees, cost effective.
The problem with banking is that it is incredibly difficult to assess the true cost of a specific service. Banks are great big bundles of cross subsidized activities, so disentangling the exact cost of service makes charging sensible prices very difficult. I have always characterized banks as mammoth bookkeeping services attached to great big lending machines. As those bookkeeping services were shifted to electronics and away from paper, the industry plunged into IT. Banks we’re amongst the first big customers for mainframe computers. They were among the first to use new database technologies. And they embraced the internet earlier than others. Banking is transactional – think withdrawing cash from an ATM of paying a bill by check. And computers lower the cost of transactions.
The problem is that in order to keep up with the ROC produced by trading, the people managing the bookkeeping functions like the branches and the payment system, and those running the lower return services like credit cards and small business lending were forced to ratchet up their fees. So the benefits of lower costs were eclipsed by rising fees. Instead of passing on the benefits to customers in the form of loser fees, the banks perversely raise fees in order to match the higher ROC targets now imposed on the industry.
The industry was thus slowly transformed, not so much in its activities, but in the perception of its ‘natural’ or sustainable return. What was once an acceptable return was no longer considered acceptable. So activities that failed to meet the newer and rising levels of desired return were de-emphasized, under invested in, or simply ignored. Capital was increasingly allocated to those activities capable of meeting the higher returns that analysts, shareholders, and even regulators were calling for as measures of competent performance. This meant trading and investment banking eclipsed old-time banking. The capture of the banking system by traders was underway.
I lived through this. Indeed I can recall conversations with our then chief financial officer as we planned to upcoming year. He was always calling for higher returns, his external advisors and our shareholder were pressing for them. I, along with others, argued that this meant taking greater and unacceptable risk. It implied getting into areas of banking that were both riskier than we were used to, and which were beyond our recent experience. We went for return. We blew the bank up.
So I have observed toxic banking firsthand, and I can recall how much of the toxicity stems from a commitment to meet unsustainable and unrealistic profit goals. Commercial and investment banking are different endeavors that need to be measured, managed, and regulated in different ways.
But that’s not the industry we have.
We have a commercial banking system with a cancerous investment banking system grafted on top. Worse, the commercial system is now subject to an investment banking style management. The cancer feeds off of and subjugates the rest. The industry is run, not for its customers, but for its executive management. And they are traders not bankers. The cultural incompatibility is stark. The banks have destabilized what was once stable. They have done this, first in response to outside nonbank competition, and then as a result of ill-advised merging of two incompatible businesses.
First they grew to offset the loss of traditional business. Then, when that failed to stem the loss, they grew by merging with investment banks. The result is manifestly a failure. An anti-social failure.
Their growth has not produced a more stable industry. Nor has it stemmed the growth of non-bank competition. All it has done is to produce organizations that sprawl across finance; are a morass of poorly fitting activities; are too big to manage; too big to fail; and too big to be useful. They simply exist in their own universe to feed themselves and to extract profit from the economy in order to justify their continued growth and existence.
We don’t need them.
They need us.
But we don’t need them.
Their size produces no value. On the contrary it destroys value. Especially in view of the cheating, market rigging, and other abuses of social propriety that they indulge in to feed the maw of their bonus cultures. They have grown to excess. They are excessive. We cannot afford them any longer.
They should go.
We need to revert back both to smaller banks and to an industry divided. So breaking up the banks ought address the misguided imposition of investment banking culture in commercial banking; and it ought to make the new banks small enough that management actually knows what it is managing, and if it doesn’t then the new banks need to be small enough to blow up without taking the economy down with them.
One last thing.
Possibly the greatest advantage of breaking up the banks will be to reduce their ability to corrupt politics. The age of deregulation has been the age of corruption. Our politics is poisoned by the cash that flows not just from the banks but from the oligarchs beyond. The Supreme Court conflated, to its eternal shame, cash with freedom of speech. This was not the beginning of corruption, but simply the affirmation of it. It was a final cynical act in the steady erosion of the balance between wealthy oligarchs and democracy. It brought clarity to the subversion of the pre-existing order by wealth, and to the clear and present danger represented by the oligarchic class to our basic freedoms. Bankers played a key and early role in this subversion. The takeover of banking by traders and their desire to prop up their ability to reap excess rewards, now, in retrospect, seems best explained as the capture of an entire industry for the personal gain of a few. A few, who once ensconced in charge, then used the profits of that industry to entrench their privilege.
So liberating banking from the traders who now run it will reduce the corruption of our politics.
Break up the banks. Break them before they break us … again.