Diana Farrell And The White House Theory Of Bank Size
Posted: 13 Oct 2009 03:07 AM PDT
On Friday morning, Diana Farrell – a senior White House official – made a significant statement on NPR’s Morning Edition, with regard to whether our largest banks are too big and should be broken up.
“Ms. DIANA FARRELL (Deputy Assistant for Economy Policy): We understand Simon Johnson’s views on this, and I guess the response is the following….
“Ms. FARRELL: We have created them [our biggest banks], and we’re sort of past that point, and I think that in some sense, the genie’s out of the bottle and what we need to do is to manage them and to oversee them, as opposed to hark back to a time that we’re unlikely to ever come back to or want to come back to.” (full transcript)
Ms. Farrell is Larry Summers’s deputy on the National Economic Council and the former director of McKinsey Global Institute, and she has a strong background on banking issues – based on extensive professional experience with global financial institutions.
Her statement contains three remarkable points.
First, “we have created them” is exactly right. Today’s mega-banks were not created by any market process. They are the result of a series of government actions and inactions, particularly over the past 18 months. Banks failed due to their own mismanagement but how those failures were handled – bankruptcy vs. bailout – was a conscious official decision. This administration deliberately chose to be very nice to the biggest banks and to the people who run them.
Second, “we need to… manage them and oversee them”. Here she is presumably referring to the administration’s regulatory reform plan, which does not appear to be going well. Once the massive banks were created, and implicitly backed by the government, it became (already by April or May of this year) very hard to reregulate them. As Joe Nocera pointed out on Saturday, the biggest banks have essentially bitten the Obama administration hand that fed them – most obviously by opposing the new Consumer Financial Protection Agency. It is already abundantly clear that the White House cannot control our big banks. What hope do mere regulators have?
Third, “we’re unlikely to ever … want to come back to”. Ms. Farrell’s specifics on this point were summarized by the interviewer, Alex Blumberg, “The problem with Johnson’s approach, [the administration] decided, is that bigness also has its benefits. Sure, the economy used to be simpler and financial institutions weren’t so big and dangerous, but GDP was smaller then, too, and people were poorer.”
I’ve reviewed the available work of Ms. Farrell, the McKinsey Global Institute, and other publicly available sources on this issue (e.g., this book, profile, and article).
I haven’t found even an assertion that our largest banks should get bigger, in absolute size or relative to the economy, let alone any facts or relevant empirical evidence. If I have missed a convincing quantification for “bigness also has its benefits,” please draw that to my attention.
Perhaps there is a reason that today’s nonfinancial companies need a financial sector that is more concentrated and more powerful politically than ever seen in living memory – maybe this emerges from the Financial Services Roundtable or the government’s more confidential interactions with CEOs. But my conversations with people who run companies or who work closely with nonfinancial executives suggest quite the opposite – they see our current financial system as dangerous, with the likely costs of big banks (e.g., future bailouts) greatly outweighing any benefits.
Here’s the end of the NPR segment, where Alex Blumberg gives a fair summary:
“BLUMBERG: In the end, what we should do about the genie comes down to how you think about it. Farrell’s view and the view of economists like Calomiris from Columbia is that the genie does lots of good things for us and that we can learn to restrain it.
For Johnson, the good things that the genie does are outweighed by the bad things and we should be thinking hard about how to get it back in that bottle before it wreaks havoc once again.”
If Ms. Farrell and the White House (or anyone else) has hard numbers we can put on the benefits of big banks, please make these public. We can then weigh these against the obvious costs of running our financial system in this fashion – on this round alone: fast approaching 40 percent of GDP, i.e., the increase in government debt as a direct result of our financial fiasco; plus persistently high unemployment; millions of homes lost; likely permanent loss of output, etc.
Philipp Hildebrand, now head of the Swiss National Bank (SNB), expressed a more moderate official position in June, “A size restriction would of course be a major intervention in an institution’s corporate strategy… Naturally the SNB is aware that there are advantages to size. [But] in the case of the large international banks, the empirical evidence would seem to suggest that these institutions have long exceeded the size needed to make full use of these advantages.”
By Simon Johnson