America needs to break up its biggest banks, but not for reasons likely to give a tingle to Occupy Wall Street’s remnant rabble (or its Great Everywhere Spirit, Senate candidate Elizabeth Warren of Massachusetts). This isn’t about some political exercise in election-year demonization. Bankers, as a class, aren’t villains. They’re not “banksters” grifting money from middle-income pockets. And they’re certainly not vampire squids on the collective face of humanity, as Rolling Stone writer Matt Taibbi has infamously described Goldman Sachs. And while it might be rhetorical overkill to say they’re “doing God’s work,” as Goldman boss Lloyd Blankfein has put it, bankers do fulfill a critical economic function. Bankers, not bureaucrats, are supposed to be the efficient allocators of capital in America’s market-based economy. They connect people who have spare dough to those who need a bit of spare dough, such as entrepreneurs looking to start a business or companies looking to grow one. We need lots of successful banks, and we need smart folks to run them.
But America doesn’t need 20 banks with combined assets equal to nearly 90 percent of the U.S. economy, or five mega-banks—JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs—with combined assets equal to almost 60 percent of national output, three times what they were in the 1990s. That amount of complexity and financial concentration—which has grown worse since the passage of Dodd-Frank—is a current and continuing threat to the health of the U.S. economy. Now don’t blame market failure or unintended results of deregulation. Banks that big and complex and interconnected are both the unsurprising outcome of Washington’s 30-year expansion of the federal safety net and the cause of its ongoing existence. When you combine a “too big to fail” guarantee from Uncle Sam with the natural human tendency toward irrational exuberance, you have the key elements in place for another unaffordable financial crisis.
Bubbles are nothing new. And the root cause of the financial crisis of 2008-2009 may have been no different than what drove manias for Dutch tulips in 17th-century Holland, shares of the South Sea Company in 18th-century England, or dot-com stocks in 1990s America. This time around, the vehicle for the market’s mania was an outbreak of cockeyed optimism about housing prices—among both lenders and borrowers—and their inability to ever decline. A new study from the Federal Reserve banks of Atlanta and Boston, “Why Did So Many People Make So Many Ex Post Bad Decisions: The Causes of the Foreclosure Crisis,” explains it this way: “Bubbles do not need securitization, government involvement or nontraditional lending products to get started. . . . If the problem was some collective, self-fulfilling mania, [a new round of regulations] will not work.”
The supporters of the Dodd-Frank financial reform law, the study suggests, diagnosed and treated the financial crisis like it was an outbreak of malaria, a preventable disaster caused by a disease whose pathologies are well understood. Change this or that incentive via this or that financial regulation and the problem is far less likely to repeat.
But that approach is as much a case of mass delusion as the one that afflicted all those owners in 2007 of sure-thing mortgage-backed securities or mini-mansions in reclaimed Nevada desert. MIT economist Andrew Lo reviewed 21 books about the financial crisis and concluded that “like the characters in Rashomon, we may never settle on a single narrative that explains all the facts; such a ‘super-narrative’ may not even exist.”
Lo finds the empirical evidence for many so-called facts that influenced Dodd-Frank to be unclear at best. We all know, of course, that Wall Street compensation was too focused on making a quick buck from short-term trading profits. Yet Lo inconveniently points out that big bank CEOs’ aggregate stock and option holdings were more than eight times the value of their annual compensation, making it “improbable that a rational CEO knew in advance of an impending financial crash, or knowingly engaged in excessively risky behavior.”