Bust Up the Banks
Roubini, Nouriel, Mihm, Stephen, Newsweek
Byline: Nouriel Roubini and Stephen Mihm
The president's half-measures won't fix our failed financial system. Here's what will.
In early January, Ben Bernanke defended the Fed's handling of the recent financial crisis. The lesson he drew was simple: better regulation could have prevented it.
This is correct. Regulation could be better and smarter. Regulators could eliminate banks' intentional evasion of regulatory oversight. They could solve the too-many-cooks-in-the-kitchen problem, in which an overabundance of regulators and a lack of coordination frustrate effective supervision of the system.
But sometimes it's not enough to impose new regulations on the status quo; sometimes a bit of regulatory "creative destruction" is in order. Many of President Obama's reform proposals are good, but they don't go far enough. There are more drastic changes that can and should be imposed in the coming years, including breaking up big banks and imposing new firewalls in the financial system. There is an even more radical idea: use monetary policy to prevent speculative bubbles.
What follows is a glimpse of the possible future of finance--if policymakers and politicians recognize that confronting crises requires radical reform.
Smaller Is Better
There's a very simple way to curtail the power of the big firms that helped cause the crisis: break them up. The recent crisis highlighted the "too big to fail" problem. The collapse of Lehman Brothers and the resulting cardiac arrest of the global financial system revealed that many institutions had become so large, leveraged, and interconnected that their collapse could have systemic and catastrophic effects.
The ranks of the TBTF club contain few traditional banks. Most belong to another species: big broker dealers like Morgan Stanley and Goldman Sachs; AIG and other insurance companies; government-sponsored enterprises like Fannie Mae and Freddie Mac; and hedge funds like Long-Term Capital Management. While the crisis left fewer such firms intact, those remaining are often larger, thanks to the consolidation that followed the panic.
Not only are such firms too big to fail, they're too big to exist, and too complex to be managed properly. They should be pushed to break themselves up. One way of doing this would be to impose higher "capital-adequacy ratios," which is a fancy way of saying that these institutions should be forced to hold enough capital relative to all the risks posed by their different units. This requirement would reduce leverage and, by extension, profits. The message: bigger isn't better.
For their part, the TBTF firms consider themselves essential to the world economy. Thanks to their scale, we're told, they offer "synergies" and "efficiencies" and other benefits. The global economy can't function without them, they say.
This is preposterous. For starters, the financial-supermarket model has been a failure. Institutions like Citigroup became gargantuan monsters under the leadership of empire builders like Sanford Weill. No CEO, no matter how adept, can manage a global institution that provides thousands of kinds of financial services. The complexity of these firms, never mind the exotic financial instruments they handle, makes it mission impossible for CEOs--much less shareholders or boards of directors--to keep tabs on every trader.
Even nominally "healthy" firms like Goldman Sachs pose a threat. Not that you would know it listening to the firm's CEO, Lloyd Blankfein, who in early 2010 defended handing out record bonuses by claiming, "We're very important. We help companies to grow by helping them to raise capital. Companies that grow create wealth. This, in turn, allows people to have jobs that create more growth and more wealth. We have a social purpose."
Spare us. Like other broker dealers, Goldman Sachs has a long history of reckless bets and obscene leverage. …