Does Size Matter?

The antithesis to market capitalism is monopoly.  High market concentration has been historically a reason to use the US Justice Department to trust bust.  We’ve had laws on the books since the late 19th century.  The last real monopoly challenge was during the Clinton administration that took on Microsoft and its software bundling practices.  The Bush 2 administration promptly walked away from enforcing the suit.  The Eurozone found Microsoft guilty of monopoly behavior and are still in the process of enforcing their court’s findings.  We’ve been ignoring monopoly-creating behavior on the part of lawmakers and corporations for decades now and we’re living with the high costs of market failure as a result.

Much of the problems in the current downturn can be traced to the behavior of some of the country’s largest banks. Banks that were allowed to grow to sizes that allowed them power in the market, power in congress, and power in the setting the terms of their regulation. Several rationalizations were used to allow banks to grow from the 1980s to present time.  First, there were the arguments for economies of scale.  Big banks were more able to process huge batches of ACH transactions and checks.  These money center banks replaced the FED as the transaction processor of choice since they were generally cheaper given the various expenses of being a FED member bank that include leaving large amounts of money in reserve and on-going regulation and monitoring.

Second, there was the argument that huge money center banks were necessary to offset the power of the up and coming huge Japanese banks.  During the 1980s period, one US bank after another on the top ten largest banks in the word was knocked off the list by a Japanese bank, then later by Eurozone banks.  It was argued that in order to compete with these larger foreign institutions, US banks concentration should be looked at in a global context.  In a global context, they were ‘competitive’ and not part of a market concentration problem.   The basis of this argument was that the bank might be big in US terms, but as a global entity it was one of many.  During the 1990s, it was typical for market concentration to be defined more on a global basis which in turn led to less prosecutions based on the traditional measures.

We now know that poor regulation and  terrible understanding of the role of financial innovations in the financial system led to the current meltdown.  We also know that many of the offenders and the biggest failures have been the huge money center banks.  Many regional and small banks that continued to follow the loan and hold model of lending, rather than the loan, securitize and sell model are still thriving and did not contribute to the current crisis.  Given the global financial crisis and the role of the mega banks and the resultant demands on tax payer funds to bailout those deemed too big to fail, should we look at regulations that  limit bank size?

Many economists, liberal pundits, and I question the Geithner plan because it assumes we need the financial system to just work as it exists today.  His paradigm doesn’t really question the failure of the system in terms of the current set-up of the system itself.  Geithner’s plan blesses the poor system that was just swept off its feet by a passing oddity that surely won’t repeat itself.  James Kwak of  Baseline Scenario questions the basis of the Geithner plan that we need just need to prop up these too big to fail behemoths until they are back on their feet.  Here’s the central part of the Geithner proposition questioned by Kwak and others.

“. . . [W]e must create higher standards for all systemically important financial firms regardless of whether they own a depository institution, to account for the risk that the distress or failure of such a firm could impose on the financial system and the economy. We will work with Congress to enact legislation that defines the characteristics of covered firms, sets objectives and principles for their oversight, and assigns responsibility for regulating these firms.

In identifying systemically important firms, we believe that the characteristics to be considered should include: the financial system’s interdependence with the firm, the firm’s size, leverage (including off-balance sheet exposures), and degree of reliance on short-term funding, and the importance of the firm as a source of credit for households, businesses, and governments and as a source of liquidity for the financial system.”

Read the rest of this entry »