Too Big to Fail: Greenspan Adds His Voice to the Break-Up Chorus

Alan Greenspan has joined the long and distinguished list of experts calling to break up the too big to fails.

As Bloomberg wrote yesterday:

U.S. regulators should consider breaking up large financial institutions considered “too big to fail,” former Federal Reserve Chairman Alan Greenspan said.

Those banks have an implicit subsidy allowing them to borrow at lower cost because lenders believe the government will always step in to guarantee their obligations. That squeezes out competition and creates a danger to the financial system, Greenspan told the Council on Foreign Relations in New York.

“If they’re too big to fail, they’re too big,” Greenspan said today. “In 1911 we broke up Standard Oil -- so what happened? The individual parts became more valuable than the whole. Maybe that’s what we need to do.”

At one point, no bank was considered too big to fail, Greenspan said. That changed after the Treasury Department under then-Secretary Hank Paulson effectively nationalized Fannie Mae and Freddie Mac, and the Treasury and Fed bailed out Bear Stearns Cos. and American International Group Inc.

“It’s going to be very difficult to repair their credibility on that because when push came to shove, they didn’t stand up,” Greenspan said.

Fed officials have suggested imposing a tax or requiring higher capital ratios on larger banks to ensure the firms’ safety and reduce some of the competitive advantage from the implied subsidy. Greenspan said that won’t work.

“I don’t think merely raising the fees or capital on large institutions or taxing them is enough,” Greenspan said. “I think they’ll absorb that, they’ll work with that, and it’s totally inefficient and they’ll still be using the savings”...

“If you don’t neutralize that, you’re going to get a moribund group of obsolescent institutions which will be a big drain on the savings of the society,” he said.

“Failure is an integral part, a necessary part of a market system,” he said. “If you start focusing on those who should be shrinking, it undermines growing standards of living and can even bring them down.”

In invoking the break up of Standard Oil, Greenspan is invoking Teddy Roosevelt's trust-busting actions. See this.

Greenspan also lends credence to those calling for using antitrust laws to break up the too big to fails.

Comments

[really:]

Why should the US break up the banks it considers too big to fail if other country's don't do this to their banks, like HSBC, Barclays, Banco Santander, UBS, Credit Suisse, etc. A US bank break-up would just create smaller banks that would be ripe for foreign banks to pick off, then Americans would own less of their domestic banks. Unless the G20 agrees to act alike, it would be like the saying goes, "cutting off your nose to spite your face." The ideal thing is to do what the Canadians do to their large, influential banks, regulate them tightly--there's got to be an offset to tremendous market influence.

Oct 16 08:14 AM

[captainccs:]

Yes, if a bank is too big to fail, it is too big and needs to be broken up, like Standard Oil in 1911 and Ma Bell in 1974-82.

Bring on the trust busters!

Oct 16 08:15 AM

[Michael L:]

Little late to the party, Al, since it was you and your bubble machine that created those too big to fail. Hush now, be a good boy, dunce cap atop your head and resume your position in the town square. Mumble on about irrational exuberance,then mumble some more about how you really didn't mean it. Don't forget to tell Ben to print some more, just like you taught him..

Oct 16 08:17 AM

[hwood007:]

How can the gov use tax payers money to create an even bigger bank, such as BAC, have BAC save Merrill Lynch, and then break it up into parts? How and who gets the money from the "increased" value? They created these too big to fail banks, so they have to live with them.

Oct 16 10:04 AM

[Ferdinand E...:]

Let's see now. Ben is a macroeconomist, and one of the best in the world where his speciality is concerned. He doesn't know anything about oil though. Al is a jazz musician who knows a little about oil and gas. I prefer jazz to macro, but even so I'll go with Ben. He and Larry have what it takes.

As for breaking up the too big to fail banks, I wonder what Ben and Larry and Mr O. think about that nutty suggestion. Maybe they don't think about it at all. I know that I wouldn't if I were in their place.

Oct 16 10:21 AM

[pragmist:]

I have no faith in anything Greenspan says.The policies followed under his tenure is what created this mess in the first place. I do not want to psycho analyze anyone, but this person will say anything that sounds good at the moment.
I would rather listen to honest Warren Buffet, who endorsed backing these banks, than Alan Greenspan, whom I always considered a lucky mentally handicapped individual.

Oct 16 10:28 AM

[pragmist:]

I have no faith in anything Greenspan says.The policies followed under his tenure is what created this mess in the first place. I do not want to psycho analyze anyone, but this person will say anything that sounds good at the moment.
I would rather listen to honest Warren Buffet, who endorsed backing these banks, than Alan Greenspan, whom I always considered a lucky mentally handicapped individual.

Oct 16 10:28 AM

[Living4Divi...:]

Breaking up is hard to do !

Breaking up the too big to fail banks is the right thing to do. While it is the right thing to do, it requires enormous political willpower to do so.
The political will to break up the big banks is not there yet in sufficient quantity.

Oct 16 10:30 AM

[bob adamson:]

"really"

You are not going to get the international community to work in lock step to address the investment bank size issue in the way that you propose and, anyway, that approach doesn’t address the root issues. The following ideas try to put the issue into a better context.

Arguably the core questions the US must ask are:
1. Whether its investment banks should also be allowed to be savings banks?
2. Where the boundary between investment banking and hedge fund activity should be drawn and how this boundary can be best maintained?
3. What regulatory system (including capitalization, assumption of risk, reporting to regulatory agencies, shareholders, customers and the public among other matters) should govern savings banks, investment banks and hedge funds respectively?
4. What system of rules and institutions should exist to monitor, assess and take expedited action when a savings bank, an investment bank or a hedge fund is in or approaching difficulties (presumably a distinct system for each of these three areas.)?
5. What are the number, size and ownership rules for US investment banks that would give the US the optimum investment banking system to serve its own and global needs?
Interestingly, the issue of whether current banks should be broken into smaller entities can not really be address until progress is made in answering these five questions.

While there are valuable insights to be learned from the Canadian (and Australian) banking systems, the Canadian experience is not exactly applicable to the large US investment banks and near banks (i.e. hedge funds and securities firms) that together became the core of the global investment banking crisis. The distinguishing factor between the two countries on this matter is one of nature and scope. New York remains the prime investment banking centre of the world while Toronto (aside from investment in the base metal and energy sectors) is overwhelmingly a national commercial and savings banking centre. Further, Canada isn’t really a hedge fund centre. In other words, Canada’s investment banking needs are served partially by its own banks and significantly by those of the US, UK and other investment banking centres while the US investment banks serve a large portion of both the US and global investment banking needs. In short, investment banking is a much smaller component in the business model of Canadian banks, that model does not involve much in the way of indigenous hedge funds and Canadian banks serve a much more restricted cliental as investment bankers.

The US and UK are the two countries with the most similar investment banking systems (and attendant problems) and the need to work together to redesign their systems.

bob adamson


On Oct 16 08:14 AM really wrote:

> Why should the US break up the banks it considers too big to fail
> if other country's don't do this to their banks, like HSBC, Barclays,
> Banco Santander, UBS, Credit Suisse, etc. A US bank break-up would
> just create smaller banks that would be ripe for foreign banks to
> pick off, then Americans would own less of their domestic banks.
> Unless the G20 agrees to act alike, it would be like the saying goes,
> "cutting off your nose to spite your face." The ideal thing is to
> do what the Canadians do to their large, influential banks, regulate
> them tightly--there's got to be an offset to tremendous market influence.

Oct 16 01:27 PM

[macrumpton:]

His idol Ayn Rand is spinning in her grave.

Oct 20 01:44 PM

[E Nuff Sed:]

The financial crisis has shown that while the "too big to fail" banks operate internationally they are "bailed out" nationally if they get into trouble. A alternative to a breakup would be to put in a regulatory regime of mandatory insurance when a financial entitiy grows beyond a certain size. The premiums would increase with size.

Other changes would have to made as well - i.e. higher capital ratio's, changes to compensation (more emphasis on long term incentives than short term cash bonuses), a ban on "dark pool" trading/exchanges and a requirement that a orginator of a financial instrument such as CDO retain a signficant portion of the risk.

For example Goldman Sach's was heavly involved in CDO's insured by AIG in a credit risk swap arrangment and would have certainly collapsed if AIG was not bailed out. GS survived because the govt bailed out AIG and protected them from the counterparty's collapse. Who benefitted? GS exec's and shareholders who have made billions within a year of imminent collapse. Who paid for it? the sheeple of the United States who are in thrall of market fundamentalists.

Oct 24 01:31 PM