The internets are buzzing with the news that Larry Summers told PBS Newshour that breaking up the banks is a bad idea. It’s not clear to me that the core of his argument is actually wrong–100,000 small banks going hog wild on subprime mortgages would not have been obviously better than 100 big ones. Indeed, it would have been . . . the savings and loan crisis. However, when the time came to bail out those behemoths, regulators did not go into a lengthy disquisition on the mystery of capital flows, and asset-price bubbles. They said the institutions they were bailing out were “Too big to fail” without explaining that the risk wouldn’t necessarily have been any safer for the economy if it had been more evenly throughout the banking system.
(One can argue that it wouldn’t have happened in the first place–but that’s a problem of regulatory oversight, not institution size per se. We managed to have a lovely Great Depression using only small banks, and a few other ingredients commonly found in most homes.)
Of course, that doesn’t mean that big banks are better for the economy, as Summers suggest. But there’s one thing he does hint at, though he doesn’t quite come out and say it: bigger banks might be better for regulators. It may not be smart to put all your eggs in one basket . . . but it’s probably a hell of a lot easier for a regulator to watch that basket. Plus, big banks provide nice lots of cushy jobs for regulators to retire into. Small banks don’t have quite the same incentives (or payrolls). This may explain something important about what’s happened in our banking system over the last few decades.
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