Bipartisan momentum is growing to break up the biggest too-big-to-fail Wall Street banks, fueled by the ongoing economic wreckage caused by the last financial crisis, the threat they continue to pose to our financial system, the significant risk of requiring taxpayer bailouts and the fact that there are very if any offsetting valid economic reasons for them to exist.
But, the biggest banks that profit handsomely from the current subsidy scheme and taxpayer-funded bailouts whenever necessary (which is why these “too-big-to-fail” banks don’t fail), continue to defend the indefensible. The latest example is a JPMorgan “Eye on the Market” research note, apparently in response to the Federal Reserve Bank of Dallas. The Dallas Fed pointed out that community banks are more focused on business lending than large banks, and that community bank lending to small business declined proportionally less in the aftermath of the crisis. (See here and here)
In response, JPMorgan claims that large banks (like itself) provide a broader range of credit than their smaller cousins – including things like bond underwriting and mortgage securitization. JPMorgan also claims that large banks are super-efficient, because they provide more credit relative to their capital than smaller banks. So, JPMorgan’s argument goes, since large banks play a big role in the financial, there is no need to restrict their size. (See here)
Consistent with other claims by the too-big-to-fail banks, the JPMorgan’s arguments ignore a few key issues, which, surprise, really lead to a different outcome.
The one big fact they never mention is that, because they are too big to fail without destabilizing the entire financial system, large banks pay a lower cost on the money that they borrow to run their businesses. The Dallas Fed points to empirical evidence showing that this subsidy is significant, which shouldn’t surprise any unbiased observer and certainly not an economist. Limiting the scale of large banks will inevitably help limit the subsidy. This will increase market discipline in the banking sector.
Another fact the biggest Wall Street banks like JPMorgan never mention is that their ability to play a central role in capital markets — through securitization, trading, and derivatives — is supported by the implicit public guarantee of their debt. Those banks would play a much smaller role in capital markets without it. They would be less able to compete on price, and less attractive to counterparties without the federal government as the ultimate guarantor.
While it is true that large banks use proportionately less capital to support the asset side of their balance sheet, their addiction to leverage is not proof of economic efficiency. It only shows that they are willing to shift greater risk onto the public, since higher leverage means they are more vulnerable to runs in times of stress. It was the large banks, highly levered and dependent on short term borrowing, that were the major users of the many Fed rescue facilities during the financial crisis.
In short, the latest defense of the too-big-to-fail banks like JPMorgan fails under analysis. Without such banks and activities, the near collapse of the financial system in 2008, the trillions of dollars required to bailout those banks, and the ongoing economic wreckage they caused across our country almost certainly wouldn’t have occurred.