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Great FinReg Argument Of Size v. Leverage Not An Argument At All

Kevin Drum thinks that we shouldn’t try to break up the megabanks because it’s functionally impossible:

My take is that that’s hopeless. There are things we can do to make banking simpler, but there’s just no way that we’re going back to the 70s. Not. Gonna. Happen. And the chances that Congress — which is barely willing to approve even watered-down consumer protections — will break up banks the way Teddy Roosevelt broke up Standard Oil? Forget it.

It’s useless to declare a problem unsolvable and then suggest instead that we tackle a problem that’s even more unsolvable. I don’t have much hope that Congress and the Fed are going to crack down on leverage in a way that’s anywhere near as broad or as strict as I’d like them to, but there’s at least a chance of making progress on this front. If we throw up our hands and declare it impossible, we’re effectively giving up on financial reform entirely.

This is basically the same argument as Jonathan Chait made last week, which discounts the value of long-term messaging campaigns that actually get the policy right. Even if you feel that breaking up the banks isn’t politically feasible at the time, shutting down discussion with that feasibility argument dooms the nation not just to technocratic, marginal fixes in the near term, but no vision of the desired end state in the long term, and thus the perception that as a politician or political party, you stand for nothing but the path of least resistance.

What’s interesting here is that Drum argues this to promote his own favored method of financial reform, focusing on capital requirements and leverage, which Steve Randy Waldman says, compellingly, cannot be properly measured. Indeed, Lehman Brothers didn’t have an outrageous leverage spread the day before they collapsed. Drum tries to rebut this even while declaring himself “out of his league” at the beginning of the argument. His argument, is, shall we say, less compelling. In doing so, he says that you can get at capital requirements by limiting shadow banking, and trading derivatives openly in exchanges, and getting rid of the off-balance-sheet deals and accounting that hampers true reporting results.

Well, this is EXACTLY WHAT PEOPLE WHO FAVOR REGULATING BANK SIZE HAVE BEEN SAYING. The non-financial bloggers in the wonkosphere seem to be constructing the mother of all straw men, arguing that those who want to break up the banks think that alone can solve the systemic problems at the root of the financial sector. Nobody I’ve read has been saying that. They all favor a both/and approach, including things like, well, derivative reform, and stronger regulations on shadow banking, and ending the accounting tricks, and even leverage and capital requirements. I don’t see the two sides in this debate at all in disagreement, other than what reforms they choose to emphasize. But there’s sure a lot of misunderstanding and misinterpreting at work. Maybe it’s because theose making these arguments know them to be theoretical, as the likely outcome will probably be pathetic on all counts, with Democrats happier to get a “win” than anything fundamentally shaking up the system. Maybe everyone’s staking out higher ground.

That said, I think it’s worth reading this anonymous bank executive writing about what would happen if the banks got broken up:

Studies consistently cite that the efficiencies (economies) of scale end and $100B or so. If that is the case, does that not make the multi million dollar men at the top of the pyramid the actual problem? Money is diverted from the branch to the Executive ranks, Private Wealth, and the Investment Bank. It is reverse Robin Hood.

So what do the majority of bankers have to fear from a break up? Nothing. It would bring management closer to the customer and the employee, create a better customer experience, more equitable pay, better teamwork, and a return to values oriented banking.

Given this common sense, all branch based folks at the thousand and thousands of branches should write their congressmen and women and Senators and ask for the passage of strong TBTF legislation that would restore dignity to their profession. Let Private Wealth and the I-Bank float on their own. If you are a shareholder in your 401K or otherwise, you will still get a piece of that action. The value of the parts is generally greater than the value of the whole anyway. It is a win-win-win except in the Executive wing and on Wall Street, which is out of touch with Main Street anyway.

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David Dayen

David Dayen