Nothing to Gain, Much to Lose, from Breaking Up Big Banks

This is an open letter to Richard Fisher, president of the Federal Reserve Bank of Dallas, who recently outlined a plan to break up big banks.

Dear President Fisher:

I am certain you have noticed the slow and steady call for the elimination of the Federal Reserve.  One of the more vocal advocates of ending the Fed was former Congressman and serial presidential contender Ron Paul. 

I am a firm supporter of the structure of the American economy and of the Fed. Even though our economy is broken, I see no reason to take a scorched-earth approach. 

Those calling for an end to the Federal Reserve have no understanding of its function.  There is no workable plan or proposal for alternatives. Yet I find no evidence of any large-scale public service announcement or educational promotions speaking to the importance or need for a central bank. 

Rather, the hunted seem to seek a diversion by hunting others. The war drums sound with another mantra: "too big to fail," "systemic risk," or "break 'em up!" 

As a theoretical economist, I have no use for terms such as "too big to fail" or "systemic risk." Why? Because they cannot be quantified.   

It is very likely that any large conglomerate could easily be broken into pieces, by business line.  General Motors was successful in selling some businesses, including GMAC.  Over the past year, that finance company, now known as Ally Financial, has sold more than a few businesses. 

So yes, banks can be broken up. But just because an action can be taken does not mean it should be taken. The question of why has never been addressed in non-emotional, quantitative terms. 

The General Accounting office just published an excellent paper titled "Causes and Consequences of Recent Bank Failures." On the inside cover is an interesting and quantifiable fact: 

"Why GAO Did This Study? Between January 2008 and December 2011—a period of economic downturn in the United States—414 insured U.S. banks failed. Of these, 85 percent or 353 had less than $1 billion in assets." 

While the large banks did take bailout money, it will all be repaid without loss. In contrast, the single largest loss to the taxpayer, via the FDIC deposit insurance fund, was IndyMac – by no means a large bank. The preponderance of evidence is that the losses were at the midsize and smaller banks. 

There is no reason to believe that a breakup and shrinkage of large banks will increase safety. Does it seem wise to take that which has never produced a loss and reduce it to the point where it fits in a smaller category that has produced losses?

Think also about the consequences for economic research. If the top banks were broken into smaller parts, regulators would have to interview hundreds or thousands of banks, and review many more call reports, to get the same national coverage they now get from the top ten. 

If the big banks were broken up, what would be the likely result? The spirit of recent regulations such as Dodd-Frank implies banking should be limited to lending only.  It supposes traditional banking is profitable and a desirable business. Is it?  From the first quarter of 2010 to the third quarter of 2012, bank profits were growing, but interest income was falling at an alarming rate. 

It seems there is a social stigma against bankers. One may vilify the leaders of the largest banks, but in the end they are business professionals. They know the difference between a business opportunity and a lost cause. Traditional banking – retail banking – is currently a lost cause. Income is falling beyond imagination. At two separate conferences this month, the consensus was that with record low interest rates, lending is a loss leader. The hope is to gain other services – fee-based services.  So if cornered, would banks shed the "other" which is profitable, or shed the traditional banking?

Suppose the red and blue American bank or the stagecoach bank gave up its charter and deposits and kept only its profitable lines. These businesses would shed 75% or more of the regulation they now must comply with. What's the down side?  There is an old saying that when heaven wishes to punish us they grant our prayers. 

So if there may be an argument against breakups, what is left?  How do we achieve the desired goal of safety and soundness?  I believe the problem is not "too big to fail" (which would not be a solvable problem) but "too big for oversight" (which is). 

How many times over the past few years have any of the top 10 banks had to restate call reports or SEC filings? If accountants can audit, supervisors can examine.

The Federal Reserve has a brilliant pilot program: Collection of line item details on commercial loan portfolios – information such as date, size, collateral type, loan rating, etc.  This program should be expanded to include mortgages, derivatives, and other assets.  I am encouraging banks to set up a clearing house that would make this data available in real time for regulators.

President Fisher, I urge caution. There is no evidence such an action as you propose would end with the desired effect. 

Finally a closing riddle: What do you call a regulator with nothing to regulate? Unemployed! If the banks surrender deposits and charters, you will not need much of a staff. But keeping the big banks intact is guaranteed employment.

I would welcome the chance to speak with you, your staff, or any reader. 

Tim Alexander is a managing director and an economist at Triune Global Financial Services, a consulting firm for banks and regulators.