Why not just break them up?
We find ourselves in a bit of a pickle.
The government basically poured heaps and heaps of cash into the financial system in order to keep it from imploding, which was almost certainly the right call, but this has had the annoying side effect of subsidizing the financial sector, in particular Goldman Sachs, which is now basically a government-supported cash machine which is making billions off of taxpayer subsidies .
It’s terribly distasteful, as Ezra Klein and Megan McArdle and others have pointed out. It’s also very bad policy, since there basically isn’t much of a free market in finance anymore.
As Howard Lindzon joked, who cares if Goldman gets its secret quant sauce stolen since it’s in the business of running the government?
But the thing is, there isn’t much we can do about it.
Or is there?
Here’s my modest proposal: why not just break up the banks?
Seriously.
All of the big ones: Goldman, Morgan Stanley, JPMorgan, Bank of America, Citigroup… Too big to fail is too big to exist, right?
EDIT: As I’ve tried to explain in the comments, the reason would basically be moral hazard: “If you screw up the global economy, ok, we’re not going to let you fail, because you’re systemically important, but we are going to break you up after the smoke clears because, hey, come on.”
But mostly it’s about culture: the financial markets are still incredibly skittish, because they don’t know if/when the financial crisis is ending, and they don’t know if/when/how the government will step in. Meanwhile a vast majority of people are angry, ANGRY (not unjustifiably so) at the bankers. This would provide national and even global cathartic closure and allow us to move on.
It’s hard to see why the bits of Goldman Sachs that underwrite bond issues can’t operate independently from the bits that account for most of the high-frequency trading on the NYSE and Nasdaq. You have boutique M&A shops and hedge funds that do each of those things without doing the other stuff, and do quite well. You might have some synergies in there but between how over-hyped corporate synergies are and regulatory China walls, I’m not sure how big they truly are.
Unlike a terra incognita Lehman-style bankruptcy, there are well-established legal frameworks for doing this: banks routinely spin off, sell and buy bits of each other, without creating counterparty risk and widespread panic. Goldman would simply spin itself off bit by bit and the remaining shell would return its symbolic assets (an $80,000 commode and Hank Paulson’s hair, perhaps) to shareholders and shut down.
There are not the ethical or legal problems that you have in a nationalization. Corporations do not have rights as such, and only exist insofar as they are a very efficient way of pooling together financial and human resources and providing products and services to the market. Shareholders would not be expropriated as such, they would only hold, say, a share of Goldman Sachs Private Equity, a share of Goldman Sachs M&A and a share of Goldman Sachs Hedge Fund for every three shares of Goldman Sachs Inc. (Actually, an unwritten agreement to jettison the brand “Goldman Sachs” for a few decades might not be such a bad thing either.) Again, legally and financially, this is very easy to do.
And politically, I suspect not much political capital would be lost by Congress in appearing to be tough on Goldman Sachs.
This would leave aside the difficult question of whether to reinstate Glass-Steagall and whether putting together commercial and investment banking is what destroyed us (or saved us, since standalone investment banks were the first to go under). No messy nationalizations with no exit strategies either.
Right after the banks are broken up, we might see a wave of consolidation and the emergence of new financial behemoths. But that wouldn’t be so bad as watching the old ones rake in billions off of taxpayer subsidies, would it? And more crucially, these smaller entities would have much less in the way of implicit government guarantees so we might actually see a little free market going on. More competition for M&A and wealth management where Goldman and JPMorgan respectively are picking up the pieces of all their fallen competitors. New entities that wouldn’t be in the business of government arbitrage so much as in the business of, you know, business.
And also, it must not be discounted, it would provide a big cathartic moment for everyone, voters, consumers and investors alike, to put the financial crisis truly behind us and start again on a sound footing.
So: why not?
I’m genuinely asking. I mean: I might be wrong about this, but why is it not even talked about and seriously considered except for the odd fringe loony? What am I missing?
Why not just break them up?
“Why not just break them up?”
My guess: because that would mean a reduction of the power and prestige of those who currently run the entire company. No more unified Goldman-Sachs means no more Grand Panjandrums of the unified Goldman-Sachs.
The only thing strong enough to counteract the influence of such powerful people on our federal government is though some sort of public outrage. Since Goldman-Sachs doesn’t yet seem to have done anything sufficiently illegal to elicit such outrage, they won’t get broken up.
— Ethan C. · Jul 19, 08:36 PM · #
And incidentally, conservatives have been advocating the same sort of thing for decades about the federal government itself, trying to return power to the individual states. We can see how successful that’s been.
— Ethan C. · Jul 19, 08:37 PM · #
Is this the same as asking for a return to Glass-Steagal but with additional regulations specific to the sub-sectors of the financial services industry? ie, not just a division between investment and commercial banking…
— JB · Jul 19, 08:40 PM · #
1. “Almost certainly the right call”???? You think letting them fail would have been worse than what we have now?
2. I seem to remember that in the 1980s there were changes in legislation that let banks do more business across state lines. I do not recall the details of what it was about, only that the WSJ editors were in favor and I was uneasy about it even though I agree with the WSJ editors about 90 percent of the time. I’m waiting for somebody to write up the history of that transition. We might want to consider undoing whatever it was we did then.
— The Reticulator · Jul 19, 08:48 PM · #
Ethan: Obviously, Goldman Sachs would not want to be broken up. But on the other hand something tells me that the Congressman or Senator who becomes the leader in the fight to break up Goldman, and succeeds, will become overnight the most popular politician in America and our next President.
May be Goldman will not be broken up simply because it has grown too politically influential. It’s certainly possible — although that would be quite sad. But it doesn’t explain why the commentariat doesn’t discuss that possibility more.
JB: Here, I’m not advocating for any change in financial legislation. In fact, I’m assuming that the various bits of the various banks that are broken up are all going to re-consolidate fast. But it might still give us a national closure and a healthier footing nonetheless. I do believe financial regulation needs some changes but that’s not the topic of my post.
The Reticulator:
Re: your point 1- Yes, I think it would have been worse, what with the whole going back to the Stone Age thing.
Re: your point 2- There has been, indeed, a lot of economic literature on the regional deregulation of the financial sector in the 1980s, some of which my fiancée studied last year (she’s an economist). The consensus seems to be that the reforms boosted the economy and the availability of credit.
— PEG · Jul 19, 08:55 PM · #
If there’s one thing I thought we’d learned from the past few years, it’s that boosting the availability of credit is not always a good way to improve the economy.
— Ethan C. · Jul 19, 11:59 PM · #
1. Could someone explain me how letting the banks fail would have had us going back to the Stone Age? Would it have required us to dump all metal tools and appliances into the ocean? Wouldn’t I have been allowed to keep my MP3 player?
2. Has there been any study of how regional deregulation created banks that were too big to fail?
— The Reticulator · Jul 20, 02:07 AM · #
PEG, I know you said you’re not advocating any change in financial legislation. But surely you wouldn’t want financial institutions broken up without legislation to enable such action, would you? And why not enact legislation that motivates the banks to break themselves up, instead of letting politicians break up banks along lines that maximize political advantage?
— The Reticulator · Jul 20, 02:43 AM · #
Might this plan be a step towards Manzi comparmentalization?
Think of what we would then have: a tier of government-supported, low-risk / low-return big commercial banks that are run by competent, but not exceptional, bankers who are paid like senior civil servants; and another tier of high-risk / high-return financials that look like the “old Wall Street” that everybody says is dead. This is a world of walls, not brakes.
— a young man · Jul 20, 02:56 AM · #
The Reticulator: Look, I don’t know about you, but I’ve read somewhere that the Great Depression might not have been a joyride. I think unemployment at some point was above two percent. I think something like three or four people lost their life savings, and possibly, after the financial system utterly collapsed, maybe one or two “real economy” businesses had to shut down when they were starved or credit. Well, the economy back then was much less dependent on finance than it is now. Credit simply makes the economy function.
When your utility has to shut down, tell me, how do you charge your MP3 player?
a young man: the Manzi compartimentalization is a very interesting idea, and I’m sure that it would not be a bad system and would probably be better than whatever we do end up with, but that’s not what this is about. It’s about creating a free market in finance again and seeing where we end up. Maybe we’d end up with a Manzi system, maybe we’d end up with a new set of financial behemoths, but they would look different.
— PEG · Jul 20, 06:24 AM · #
OK, so now it’s no longer the Stone Age but the Great Depression. Still, could someone explain how letting the banks fail would have got us there instead of where we are now? And once we get that explanation, how likely that scenario would have been?
I really and truly am interested in any readable explanation of how regional deregulation may have created banks that were too big to fail.
— The Reticulator · Jul 20, 03:02 PM · #
“If an institution is too big to fail, perhaps it is too big to let live.” I forget which of my friends said that, but I think it’s true.
— Erik Vanderhoff · Jul 20, 05:00 PM · #
I’m not following this. First of all, citing Matt Taibbi isn’t actually the road to credibility, but let that go. Is the point of the post that it is somehow unjust for Goldman Sachs to make so much money, or that is somehow socially harmful? Because, as to the first point, there are surely much worse injustices to be concerned about. Why not break up Harvard, or the Yankees, or something? And I would need to see some empirical evidence, or at least a cogent theoretical argument, not mere hand-waving, for the claim that the existence of Goldman Sachs is socially harmful.
— y81 · Jul 20, 08:54 PM · #
If an institution is too big to fail, perhaps it is too big to let live.
I steal that line.
— The Reticulator · Jul 21, 01:47 AM · #
y81: I’m not saying why, I’m asking why not.
But the why is basically moral hazard. If you screw up the global economy, ok, we’re not going to let you fail, because you’re systemically important, but we are going to break you up after the smoke clears because, hey, come on.
Heaps of research have shown that managers are drawn to “empire building”, ie wanting to build the biggestest company EVAR, often at the expense of shareholder value and common sense business strategy, which explains why M&A arbitrage is such a lucrative business.
Since we can’t put them in jail, since they would have to do stuff that’s illegal, not just distasteful, and since a lot of people (me included) would be somewhat uncomfortable with executives sent to the brig by executive fiat and/or populist wrath, a breakup seems like a good compromise for me.
— PEG · Jul 21, 09:42 AM · #
1. The Federal Deposit Insurance Corporation has considerable institutional memory in acting as a receiver and operator of bust deposits-and-loans banks. They operated Continental Illinois Bank, which had the equivalent of $92 bn in assets as measured in today’s currency, for 10 years. The thing is, roughly half of the 30 largest banks in the United States engaged in securities underwriting or proprietary trading or prime brokerage, activities that were not conjoined to deposits-and-loans banking for 66 years; in addition, two of the largest banks, Citigroup and Bank of America had masses of uninsured deposits abroad (about 70% and 10% of their total deposits, respectively).
2. There has been for about 25 years now discussion in the business press of ‘Chinese walls’ erected to prevent information flowing from one part of a business to another as such generates conflicts of interest. I think there is a strong suggestion in such practices businesses so insulated from eachother should not be conjoined in a single enterprise.
3. It would seem from the sequence of events last fall that what generated such panic was the uncertainty over the effect of the credit default swaps on Lehman bonds would have on the solvency of other institutions. IIRC, once the swap auction was completed and the funds changed hands, the elevated inter-bank lending rates returned to earth and the quantum of financial commercial paper in circulation stabilized.
4. It has been forgotten, but Drexel, Burnham, Lambert was liquidated in 1990 without the world blowing up.
All of which suggests we might consider the following:
—Eliminate by law credit default swaps and insurance on financial products.
—Separate deposits-and-loans banking from securities underwriting, proprietary trading, private equity, and prime brokerage.
—Have securities underwriting, proprietary trading, prime brokerage, and private equity each be stand-alone businesses conjoined to no other business;
—Have the assemblage and vending of funds not be conjoined either to trust administration, retail brokerage, investment counseling, treasury services, or insurance.
—Require that deposits and loans institutions in this country divest themselves of their foreign deposits.
All of this would require that Citigroup, JP Morgan Chase, Bank of America, Goldman Sachs, and Morgan Stanley be broken up into between six and nine pieces each. (Wells Fargo appears to limit itself to domestic deposits-and-loans banking, retail brokerage, and investment counseling and custodial services).
— Art Deco · Jul 23, 03:08 AM · #