Diana Farrell And The White House Theory Of Bank Size 19 comments
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By Simon Johnson
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.”
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It's time to call out the trust busters. Breaking up Ma Bell did wonders for communications. Breaking up mega-banks would do the same for the realm of finance.
Lobbyists from the financial industry have paid hundreds of millions to Congress and the Obama administration. They have bought virtually all of the key congress members and senators on committees overseeing finances and banking.
This is easy to confirm in black-and-white. See for yourself: here, here, here, here, here and here.
Manhattan Institute senior fellow Nicole Gelinas says:
The too-big-to-fail financial industry has been good to elected officials and former elected officials of both parties over its 25-year life span
And economic historian Niall Ferguson says:
Guess which institutions are among the biggest lobbyists and campaign-finance contributors? Surprise! None other than the TBTFs [too big to fails].
No wonder two powerful congressmen said that banks run Congress.
No wonder two leading IMF officials, the former Vice President of the Dallas Federal Reserve, and the the head of the Federal Reserve Bank of Kansas City have all said that the United States is controlled by an oligarchy.
With the exception of a handful couple of Congress members who have the American people's interest in mind, Congress is bought and paid for.
Fat chance.
On Oct 13 08:36 AM Harry Tuttle wrote:
> In addition, Ms Farrell, Mr. Summers, Mr. Geithner et al should forgo
> any chance of following in Mr. Rubin's steps by accepting employment
> in any of the banks they have created with taxpayer money.
>
> Fat chance.
On Oct 13 09:21 AM Ferdinand E. Banks wrote:
> Interesting, very interesting, but I know one thing about so-called
> "big banks". That expression will never be mentioned in a classroom
> of mine by anyone who desires a passing grade - although instead
> of failing them I might just tell them a few things that they don't
> want to hear. Even so, I think that Michael Clark has a good idea
> when he says that some new laws are needed. The first new law should
> be one designed to stop people from talking about things that they
> know absolutely nothing about.
I find some absolutely ridiculous factors in this situation.
1. Farrell said: "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.”
If we have created these structures, it is disingenuous to maintain that we can not "uncreate" them. The only reason for proposing what Ms. Farrell does could be called a "Dr. Frankenstein complex". By my analysis, the model of Dr. Frankenstein's monster has some relevance. But I reject Ms. Farrell's illogical conclusion that the monster can not be deconstructed.
We can do something as simple as segregating commercial and investment banking for starters.
2. Simon wrote: " If I have missed a convincing quantification for “bigness also has its benefits,” please draw that to my attention."
Simon is right on target. This implication that "bigness has benefits" has validity for critical mass arguments. Larger than that, the best that can be obtained after some point is minor gains achieved against the tide of the law of diminishing returns.
3. Consider this paragraph: "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.”
Ms. Farrell is living in an antiseptic bubble. When our GDP was approximately half of what it is today, the financial sector had less than 15% of S&P 500 earnings (recently they have been over 40%), the percentage of income concentrated in the top 1% was much lower (11% then) than today (23%) and the percentage of the people in poverty was about the same (13-14%). The transfer of income has come from 85% of the people between poverty and the very rich to the top 1%.
Further examples, using 1984 as a reference. That is when real GDP was about 1/2 of what it is now.
a. In the 25 years befor 1984, nominal average annual personal income gains were 8.9%; since 1984, they are 5.2% annually.
b. In the 25 years before 1984, real disposable incomes rose at 4.1% annually; in the 25 years since 1984 real disposable incomes have risen 2.6% annually.
In the bubble Ms. Farrell lives (the top 1%), things have not been so good since 1929. For the other 99%, her perspective is nonsense.
Simon's concluding two paragraphs are crucial:
"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.
Simon has isolated the critical factors: The mythology generated to perpetuate economic advantage for the wealthy bankers at the top of the food chain (Ms Farrell) and the rational argument implying that the law of diminshing returns may have been ignored in the power grab (Mr. Hildebrand).
This is a great article.
Or maybe we should have anticipated precisely this, given the mantra, at least those of us who are often of the contrarian philosophy!
All you "too big" people out there, I wonder why you aren't writing to your congressional representatives to break up Microsoft also. You can't have it one way for one industry and anohter way for a different industry.
Let a free market reign and eventually, the poorly run will fail.
On Oct 13 08:53 PM John Lounsbury wrote:
> Let me add one more factoid for Ms. Farrell. The most recent doubling
> of real GDP took 25 years (1984-2009); the doubling before that took
> 20 years (1964-1984); the doubling before that took 21 years (1943-1964);
> and the doubling before that took 9 years (1934-1943). There is nothing
> in the growth rate of real GDP to support her argument that the concentration
> of economic power over the last 25 years was an advantageous event
> compared to the preceeding 50 years.
----------------------...
I can only say "Thank You" to John Lounsbury for stating the fundamental flaws in the logic being used in official discussions by the admisistration's representives (Larry Summer's office) so susccinctly.
Unwarranted certainty (or arrogance) is a problem.
The logic of so many of our financial people indicates a shallow background in the education process. The LTCM models (Merton & Scholes models) using "standard" statistics to access risk would have caused a failure of "The Chase" if the treasury had not provided a bailout. The principals had never understood that statistical events assume no communication between the events. Their reasoning was fundamentally flawed. One die rolled does not communicate with the other die; coins have no memory.
Financial dynamics are, in reality, very complex. Qualifications for an MS degree in finance should require a course of tensor analysis as it applies to financial dynamics just as it is required of engineers in the better engineering schools.
The best example in recent history is Ma Bell in 1982. Broken up successfully under antitrust. It's the nature of capitalism that they're recombining almost 30 years later.
If we start our trust-busting there, the rest is easy.
"All you "too big" people out there, I wonder why you aren't writing to your congressional representatives to break up Microsoft also. You can't have it one way for one industry and anohter way for a different industry. Let a free market reign and eventually, the poorly run will fail."
This is precisely our complaint. Too big HAS failed, but unlike companies in any other industry these banks still exist. Their shareholders have not been wiped out. Their employees have not been thrown out of work with no severance pay and no pensions as happens in other grossly insolvent bankrupt companies. Their successful, solvent competitors are not presently feasting on their assets at firesale liquidation auctions.
Instead the TBTF honchos are still paying themselves billions of dollars in "bonuses". I suppose they deserve a big bonus for "succeeding" in controlling the government and f___ing American taxpayers out of hundreds of billions of dollars.
I'm not arguing that we should have let capitalism run its course and wiped out these failures last winter. I don't want a Depression any more than Ben Bernanke does. What I do want is for the failure to be acknowledged and some discipline to be accepted by these people. Failure is supposed to be humbling, not exhilarating and highly profitable.
Shortly before the central bankers get-together in Jackson Hole last summer Kansas City Fed President Thomas Hoenig (who was hosting the conference) published "Too Big Has Failed", in which he advocates an orderly unwinding of these failed businesses. So even among the monetary elites within the Fed there is not consensus that these megabanks should be allowed to exist. Sadly, I saw no mention of Hoenig post-Jackson Hole. His rational approach to actually solving the financial logjam was likely ignored just like BIS economist William White was ignored by Greenspan when he stridently warned of the bubbles that were forming. These TBTF guys are making WAY too much money to let a little thing like causing an economic crisis with mass unemployment and currency devaluation bother them.
There are valid arguments for economies of scale. A one man shop can neither afford nor utilize a $400,000.00 machine that does the work of 100 men. A larger scale operation can afford and use the machine to vastly increase its productivity which ultimately reduces costs to consumers.
But when an operation gets so large that no individual ever knows everything that's going on in the company at any given time, then the operation becomes LESS efficient. All kinds of redundancies and other waste happen because the big picture of the company is too big for one person to see. From that point up the only reason these too-big-to-be-efficient companies appear to be 'efficient' is that they enjoy oligopoly pricing power. The consumer (or the taxpayer) can be made to subsidize the inefficiencies so the company remains highly profitable even while overpaying its employees and wasting large amounts of its resources.
I would argue that the TBTF "bank-like businesses" are in this latter category. They get laws and regulations written that favor them over their competitors. They have large scale money that enables them to move markets, and profit on the moves because they alone know beforehand which direction they are going to move the market. They are allowed to park their computers at the NYSE to front run and 'tax' equity trades.
All of this enhances profitability for these companies, but all of these "excess profits" are not from creating additional value but from sucking money away from everyone else in the economy. By this standard IRS employees should also be paying themselves billions in bonuses because the taxman is the money sucker par excellence.
As John Lounsbury implies in his comment above, overconcentration of wealth is an economy killer. It is not "envy" that should motivate policymakers (and shareholders) who want to rein in the big bankers. It is the desire for a sustainable economy and for sound economic policy that should motivate them.
They recognized the bankers for what they were, and that was before almost 250 years of financial engineering.
etext.virginia.edu/jef...
"I believe that banking institutions are more dangerous to our liberties than standing armies . . . If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] . . . will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered . . . The issuing power should be taken from the banks and restored to the people, to whom it properly belongs." -- Thomas Jefferson -- The Debate Over The Recharter Of The Bank Bill, (1809)"
"The bold effort the present bank had made to control the government
... are but premonitions of the fate that await the American people
should they be deluded into a perpetuation of this institution or the
establishment of another like it." Andrew Jackson To Congress in 1836, Jackson closed the second Federal Bank (est. 1816) with these comments
"Painting the picture that the governemnt and the banks are in cahoots is WAY off base." Citation? Argument? Just look at the numbers of regulators, economic envoys to the G20, Treasury Secretaries, protégées, bank and thrift regulators and others who are from Goldman Sachs alone, or those that go from regulating agencies to Wall Street and, like Carl Sagan used to say, "extraordinary claims require extraordinary proof." GreedCanBeGood offers nothing but empty assertion. He would have us suspend human nature (that our regulators are saints and suffer no conflicts of interest) in order to believe in an unregulated system based on the exact opposite qualities of human nature.
Fantasy and rubbish. Anyone fool make a mistake but it takes true genius operating under moral hazard to crash an economy.
BTW, I'm a free market capitalist. Imagine what the average American thinks.
Mike
> is WAY off base."
Richard Friedman was chair of NY Fed and on the board of Goldman Sachs while GS was secretly getting bailed out. Before the bailout was public, he bought 50,000 shares of GS and made a lot more than Martha Stewart did. He resigned from the Fed days later, but he