Thursday, November 14th, 2019

Who Loses if Large Banks Are Broken Up?

 

Will “too big to fail” banks become “too big to survive”? On the campaign trail Donald Trump talked about breaking up the big Wall Street banks. Now President Trump has brought up the same subject. The New York Times wonders if Trump will do a number on the big banks.

For a brief moment, Wall Street stopped on Monday, as if time was suspended in an alternative reality.

President Trump, for the first time as resident of the White House, said aloud that he was considering breaking up the nation’s biggest banks. Of course, he had said it on the campaign trail, but this seemed different.

“I’m looking at that right now,” Mr. Trump told Bloomberg News during an interview in the Oval Office. “There’s some people that want to go back to the old system, right? So we’re going to look at that.”

One can be excused for not knowing is this is a random thought or the beginning of a real policy, considering how the president’s attention to subjects comes and goes but maybe this will happen. If so, who loses if large banks are broken up?

Glass-Steagall Act

What is being talked about is a rebirth of the Glass-Steagall Act. Investopedia discusses the act.

In 1933, in the wake of the 1929 stock market crash and during a nationwide commercial bank failure and the Great Depression, two members of Congress put their names on what is known today as the Glass-Steagall Act (GSA). This act separated investment and commercial banking activities. At the time, “improper banking activity,” or what was considered overzealous commercial bank involvement in stock market investment, was deemed the main culprit of the financial crash. According to that reasoning, commercial banks took on too much risk with depositors’ money.

In a deregulation binge the Glass-Steagall Act was repealed in 1999 through enactment of the Gramm-Leach-Bliley Act which allowed banks to engage in both commercial and investment banking and to underwriting of insurance. Then 9 years later came the Great Recession and many have blamed the too big to fail banks and their involvement in commercial and investment banking for the crash.

What Happens If

If, in fact, Trump and the congress go ahead with a new version of Glass-Steagall what will happen? First of all the big banks will need to decide like they did in the 1930’s whether they want to be in commercial or investment banking.

Be Careful What You Wish For

Forbes says to be careful what you wish for if you want to break up the big banks.

A popular refrain on the left AND right ever since the financial crisis* is that to ensure nothing like it happens again, the banks must be broken up. Explicit here is that if no bank is too large, no one entity can ‘threaten the financial system’ if calamity strikes. They also presume that smaller banks mean no more bailouts. Both are nice thoughts, yet totally divorced from reality.

Only two US banks rank in the top ten worldwide and those are JPMorgan Chase and Bank of America at numbers 9 and 10! Forbes warns that breaking up the big banks and over-regulating them will lead to a drain of talent as well as make them beholding to politicians.

Talent-free banks acting as utilities might appeal to some. They would even appeal to me in a certain sense. Bernanke et al told us that absent the bailouts of the banks that credit would dry up on the way to a staggering recession, but the real truth is that most finance and lending has long occurred outside the banking system. In that case, if politicians want the banking sector to resemble the U.S. automobile industry, fine.

Maybe you want to put options on your bank stocks until this plays out.

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