Should We Break Up the Banks?

When it comes to banking policy, there are few people I respect more than Jonathan Macey and Arnold Kling; so when these two, independently, argue that we should be breaking up the largest banks, it is idea that merits consideration.  Yet I still have my doubts.

First, lets start with what we are fairly certain of.  There is a large empirical literature that suggest most US mega-banks are beyond their efficient size.  There is a good survey of the literature by former Fed Economist Allen Berger .  So, at a minimum, the academic literature suggests the largest banks are beyond a size that is justified by the social benefits.

However, there is also a small literature that suggests more concentrated banking systems are more stable, and less prone to crisis.  Some of this literature has grown out of research efforts by the World Bank.  While this literature is largely cross-country comparisons, recalling our own banking history gives several examples - the savings & loan crisis, the mass of small banks failures in the 1920s and 1930s, and current day Georgia - where lots of small bank failures have been associated with significant economic damage.  So, at minimum, there is some question of whether breaking up the largest banks would give us a more stable, less crisis-prone system.  In fact, there is considerable evidence to suggest that breaking up the banks would make our financial system more fragile.

To some extent, the debate over breaking up the large banks is about reducing political power.  The argument is that, because of their vast resources, these large banks unduly influence and capture our political system.  Undoubtedly, I believe the largest banks have substantial influence over both our legislative and regulatory systems.  However, so do smaller banks.  From my seven years as staff on the Senate Banking Committee, I would definitely argue that the Independent Community Banks Association (ICBA), as a group, has far more pull than does say Bank of America, as a single company.  One need only witness the various exemptions for small banks in the Dodd bill, for instance from the consumer protection bureau, to illustrate the lobbying power of small bankers.  One could also argue that the economic history of progressive era legislation, like the Sherman Act, is one of smaller, organized interests winning against larger sized firms.  Despite its appeal, the assertion that bigger is always better in politics is just an assertion.  Yet this is at heart an empirical argument, and perhaps one that can be tested.  Until then, I still have my doubts.