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Breaking up the banks

GB Geo-Blog

Breaking up the banks

Paul Volcker and others have recommended a return to the Glass Steagall era in the U.S., whereby banks would be prohibited from engaging in investment banking activities, including trading on their own account. This is the best idea for changing the regulatory regime for financial institutions, especially the large commercial banks.

I am a firm believer in simplicity. Banks should focus, as Volcker has suggested, on their traditional commercial banking activities — accepting deposits, making standard loans and managing the payments system.

Commercial banking would be boring, but more stable. Some would still run into trouble every once in a while when the yield curve moved against them and/or their loans were highly concentrated in a particular region or sector. Of course, they could hedge against such risks, but their hedging should take the form of buying insurance.

The commercial banks might not attract the “best and the brightest”. But who cares? The banks play a critical role as financial intermediaries, and deposit insurance is in place to prevent liquidity crises for them. Dull and boring are needed!

The two primary arguments in favor of abolishing Glass-Steagall in 1999 were that the banks would increase competition in several investment banking activities, and there might be economies of scale. I do not believe that the banks have contributed to any significant increase in competitive benefits, for the banks bought their way into the field by leveraging their balance sheets. As for economies of scale, well why are we discussing how to prevent banks from becoming “too big to fail”?

Economies of scale is a concept bandied about to justify all types of ridiculous mergers. Synergy is another such concept. (What would investment bankers do without spreadsheets and lackadaisical boards?) However, experience shows that dis-economies of scale — the inability to manage and control ever larger companies — is the more likely outcome. As for synergies, go talk to the folks at Time Warner. Simplicity!

Unfortunately, Volcker is being ignored. Instead, the regulatory proposals focus on executive compensation and other mundane matters.


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