Can the size of the largest banks be defended?
If Charles Calomiris’s attempt in the Wall Street Journal today is any sign, the answer seems to be a resounding NO.
Calomiris, a finance professor at Columbia, defends large, complex, global financial institutions by pointing out that integrated firms enjoy many efficiencies and benefits that smaller, local firms do not.
- Banks need to be large so they can be global. They need to be global because their clients are global.
- Big banks can enjoy ‘economies of scope’ by offering different products from within the same firm.
- Gains from size can benefit customers, especially in developing countries previously hindered by crony-capitalism.
- Global banks have made stock and bond markets more efficient.
You almost have to admire Calomiris for attempting to defend giantism in banks at a time when the rest of us are worried about the ‘Too Big To Fail’ problem. And we would register our admiration if Calomiris had laid out a persuasive case for big banks. If such a case can be made, however, this certainly isn’t it.
In the first place, every single one of the benefits Calomiris describes looks like rent-seeking wealth redistribution in light of the bailouts of the world’s biggest banks. The benefits of global banking may accrue to global corporations that are their customers, but when they fail the cost is born by local taxpayers. Even if those benefits outweigh the costs of bailouts (an extremely doubtful proposition), there’s no reason we should allow this kind of redistribution.
More importantly, Calomiris doesn’t really explain what we can do about the problem of Too Big To Fail. As we’ve explained, the knowledge that giant financial institutions will not be allowed to fail not only encourages excessive risk taking, it also makes risk management impossible. The market process no longer sends signals about risk, which deprives bankers of the market data they need to effectively run their banks. Capital formation is warped, credit and equity markets distorted, and giant opportunity costs incurred because of malinvestment. The phrase ‘moral hazard’ doesn’t even begin to capture the calamity of Too Big To Fail.
So what’s Calomiris’s answer? He says international regulators should have “prearranged, loss-sharing arrangements that assign assets to particular subsidiaries based on clear rule.” Your guess is as good as ours about what this would do to discourage bailouts or how deal cut between regulators could be counted on to stay in place during a global financial crisis. The behaviour of various regulators during the last crisis–such as the UK’s FSA refusing to cooperate with the proposed Barclay’s bailout of Lehman, the IRS suing UBS–hardly suggests that global crises encourage international cooperation.