Milken Institute Debate : Should Big Banks Be Broken Up?
AT A MILKEN INSTITUTE EVENT ON MONDAY, the question “Should Big Banks Be Broken Up?” took center stage.
Milken Institute – Should Big Banks Be Broken Up? A Debate
Simon Johnson, Professor of Entrepreneurship at MITs Sloan School of Management, and Harvey Rosenblum, Executive Vice President and Director of Research at the Dallas Federal Reserve, argued that big banks should be broken up. Philip Swagel, Senior Fellow at the Milken Institute, and Peter Wallison, the Arthur F. Burns Fellow at the American Enterprise Institute, voiced their opinion that large banks should remain intact because the economic costs of breaking them up outweigh the benefits. The debate was moderated by the Senior Managing Director of the Milken Institute, Bradley Belt.
In his opening remarks, Rosenblum said banks that are “too big to fail” are major roadblocks in the path to economic opportunity and are a “perversion of the capitalist system.” He warned that the largest financial institutions must be restructured and downsized or another large financial crisis could occur very soon. Rosenblum also stressed the need to open the market to more competition and reduce the role of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) as a safety net for large banks. He stated that if the public knew there would be no more bailouts, large banks would change their own structure. Rosenblum concluded that changing the rules of the game would increase market discipline and reduce the risk of another crisis, but noted that the Dodd-Frank Act not only fails to accomplish this goal, but favors big banks and perpetuates “too big to fail.”
Swagel responded that economies of scale and scope exist at big banks and breaking them up would lead to missed opportunities and losses from forgone financial activity. He noted that changes have occurred since the financial crisis that have made big banks safer, including increased capital ratios and the payment of deposit insurance premiums. Further, work is being done to establish an orderly liquidation authority (OLA), which will ensure proper resolution of a failed institution. Swagel also said that liquidation could include haircuts imposed on failed bank holdings, or debt for equity swaps, both of which were not available during the last financial crisis. In closing, Swagel voiced his concern that if the banks are broken up, financial activity could move to less regulated entities such as shadow banks and foreign institutions, increasing systemic risk.
Johnson questioned the ability of an OLA to execute a cross-border resolution, postulating that if a large, global bank fails, there will be a run on assets by all relevant regulators, making global orderly liquidation impossible. Problems also arise when determining what to do with the assets and liabilities of subsidiaries in a failed institution, he said. Johnson also expressed his view that the magnitude of bank size is problematic, citing a recent analysis which concluded that the assets of the six largest firms are roughly equal to 60% of U.S. GDP and advocating for a $250 billion asset limit. “The banks are borrowing money at a lower rate which can be viewed as a government subsidy that is unfair to smaller competitors and could promote excessive risk taking,” Johnson concluded.
Wallison reiterated the negative impacts of breaking-up large financial institutions. He worried that banks would be forced to lay off workers and renegotiate contracts, lines of credit, and business relationships, ultimately putting them in a worse financial state. He was also skeptical that smaller banks would reduce the risk of having another financial crisis, explaining that large banks did not cause the crisis, but were victims of a housing market meltdown. As an alternative, Wallison argued for increasing capital requirements and insurance premiums to extract big bank’s funding advantage.
Question and Answer
During the brief question and answer portion of the program, the idea was put forth that larger banks may be more resilient to market disruptions than smaller ones due to their greater diversification of assets. Rosenblum responded that two large financial firms “essentially failed” during the crisis when their stock price tanked and their management was gutted, but were able to keep their names because the government propped them up. Another audience member asked where to draw the line if a large bank is forced to break up. Swagel stated that if a ring fence was put in place, changing the structure of the organization, it could be seen as a break up.
The debaters ultimately concluded that proper handling of this issue is essential for the well-being of the global capital markets and all agreed that further debate and discussion is needed.
For a webcast of the meeting please click here
AT A MILKEN INSTITUTE EVENT ON MONDAY, the question “Should Big Banks Be Broken Up?” took center stage.
Milken Institute – Should Big Banks Be Broken Up? A Debate
Simon Johnson, Professor of Entrepreneurship at MITs Sloan School of Management, and Harvey Rosenblum, Executive Vice President and Director of Research at the Dallas Federal Reserve, argued that big banks should be broken up. Philip Swagel, Senior Fellow at the Milken Institute, and Peter Wallison, the Arthur F. Burns Fellow at the American Enterprise Institute, voiced their opinion that large banks should remain intact because the economic costs of breaking them up outweigh the benefits. The debate was moderated by the Senior Managing Director of the Milken Institute, Bradley Belt.
In his opening remarks, Rosenblum said banks that are “too big to fail” are major roadblocks in the path to economic opportunity and are a “perversion of the capitalist system.” He warned that the largest financial institutions must be restructured and downsized or another large financial crisis could occur very soon. Rosenblum also stressed the need to open the market to more competition and reduce the role of the Federal Reserve and the Federal Deposit Insurance Corporation (FDIC) as a safety net for large banks. He stated that if the public knew there would be no more bailouts, large banks would change their own structure. Rosenblum concluded that changing the rules of the game would increase market discipline and reduce the risk of another crisis, but noted that the Dodd-Frank Act not only fails to accomplish this goal, but favors big banks and perpetuates “too big to fail.”
Swagel responded that economies of scale and scope exist at big banks and breaking them up would lead to missed opportunities and losses from forgone financial activity. He noted that changes have occurred since the financial crisis that have made big banks safer, including increased capital ratios and the payment of deposit insurance premiums. Further, work is being done to establish an orderly liquidation authority (OLA), which will ensure proper resolution of a failed institution. Swagel also said that liquidation could include haircuts imposed on failed bank holdings, or debt for equity swaps, both of which were not available during the last financial crisis. In closing, Swagel voiced his concern that if the banks are broken up, financial activity could move to less regulated entities such as shadow banks and foreign institutions, increasing systemic risk.
Johnson questioned the ability of an OLA to execute a cross-border resolution, postulating that if a large, global bank fails, there will be a run on assets by all relevant regulators, making global orderly liquidation impossible. Problems also arise when determining what to do with the assets and liabilities of subsidiaries in a failed institution, he said. Johnson also expressed his view that the magnitude of bank size is problematic, citing a recent analysis which concluded that the assets of the six largest firms are roughly equal to 60% of U.S. GDP and advocating for a $250 billion asset limit. “The banks are borrowing money at a lower rate which can be viewed as a government subsidy that is unfair to smaller competitors and could promote excessive risk taking,” Johnson concluded.
Wallison reiterated the negative impacts of breaking-up large financial institutions. He worried that banks would be forced to lay off workers and renegotiate contracts, lines of credit, and business relationships, ultimately putting them in a worse financial state. He was also skeptical that smaller banks would reduce the risk of having another financial crisis, explaining that large banks did not cause the crisis, but were victims of a housing market meltdown. As an alternative, Wallison argued for increasing capital requirements and insurance premiums to extract big bank’s funding advantage.
Question and Answer
During the brief question and answer portion of the program, the idea was put forth that larger banks may be more resilient to market disruptions than smaller ones due to their greater diversification of assets. Rosenblum responded that two large financial firms “essentially failed” during the crisis when their stock price tanked and their management was gutted, but were able to keep their names because the government propped them up. Another audience member asked where to draw the line if a large bank is forced to break up. Swagel stated that if a ring fence was put in place, changing the structure of the organization, it could be seen as a break up.
The debaters ultimately concluded that proper handling of this issue is essential for the well-being of the global capital markets and all agreed that further debate and discussion is needed.
For a webcast of the meeting please click here