In praise of big banks | FT Alphaville

In praise of big banks

Here’s a rarity – someone arguing that the whole “too big to fail, too big to exist” idea in financial market reform  is just plain silly.

The structured finance lawyer who blogs as Economics of Contempt has stuck his head above the parapet to explain why banks actually need large balance sheets – to act as market makers, of course – and, in the process, bring down the cost of capital for everyone else.

So why do we need these massive market-makers in the first place? They ensure liquidity in the capital markets. And why is that important? For one thing, it lowers borrowing costs—investors are much more willing to buy a bond issue if they know they can quickly and easily sell the position later if they want to. Investors demand higher yields for illiquid bonds. The benefits of having massive market-makers were passed on to all the businesses that were able to borrow in the capital markets at a much lower cost, and to all the investors who enjoyed much higher returns due to the reduced transaction costs.

Still, he’s pretty sure that there is no chance of the major banks actually being broken up:

Tim Geithner isn’t an idiot, and he’s not an attention-craving pundit. Unfortunately, most pundits are apparently unable to distinguish between recognizing the benefits of big banks and being “captured by Wall Street” (which is a red herring).

Trouble is, some people will just assume that it is EoC who has been captured. As one commenter put it:

If big banks were able to sufficiently manage the risks from their activities, why did the system need critical exogenous support at a critical moment? or, are you implying that the banks we have are not big enough. if so, what size bank is big enough?

But wait!  EoC looks to have struck a cord here.  Jamie Dimon of JP Morgan, which employs 220,000 and so can be considered to be on the large size, has now popped up in the Washington Post arguing that the actual term “too big to fail” must be excised from our vocabulary:

Artificially limiting the size of an institution, regardless of the business implications, does not make sense. The goal should be a regulatory system that allows financial institutions to meet the needs of individual and institutional customers while ensuring that even the biggest bank can be allowed to fail in a way that does not put taxpayers or the broader economy at risk.

Creating the structures to allow for the orderly failure of a large financial institution starts with giving regulators the authority to facilitate failures when they occur. Under such a system, a failed bank’s shareholders should lose their value; unsecured creditors should be at risk and, if necessary, wiped out. A regulator should be able to terminate management and boards and liquidate assets. Those who benefited from mismanaging risks or taking on inappropriate risk should feel the pain.

Related links:
J.P. Morgan’s Dimon Takes On Washington’s Critics of Big Banks
– Washington Wire, WSJ
Too big to fail arguments hark back to Gosplan
– letter to the FT