Debate Club

Consumers Lose If Banks Are Broken Up

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The idea of breaking up America's biggest banks into small, bite-sized units is being billed as an antidote to "too-big-to-fail," the notion that the biggest banks must never be allowed to fail because of the damage a collapse would have on the economy. Cutting the large banks down to a more digestible size neatly solves the problem, supporters say.

The argument is temptingly simple, but deeply flawed. This implied bail-out guarantee puts taxpayers on the hook and puts competitors at a disadvantage. But limiting the size of banks would do little to fix "too big to fail," while doing much to harm the financial system and the U.S. economy.

Large banking firms such as Citigroup, JP Morgan Chase, Bank of America and Wells Fargo serve a critical role in the financial ecosystem. Operating on a global scale, they are especially important to U.S. firms operating worldwide. Large firms can also cut costs for customers domestically by spreading the costs of infrastructure, technology and other capital expenses over a larger base. If they are broken up, the ability of these banks to provide global services would erode, while costs would rise. The ultimate losers would be American consumers and the U.S. economy.

[See a collection of political cartoons on the economy.]

In any case, given the dynamism of the market, calculating the "correct" size or banks would be an impossible task for regulators. And perhaps most importantly, limits on bank size would not resolve the concerns that underlay the "too big to fail" doctrine. Despite its catchy phrasing, "too big to fail" is not purely about size. A small but highly leveraged and interconnected firm can actually present a more serious systemic risk than that of a big bank.

Nor is the concern limited to banks. Non-bank financial firms – such as insurance company AIG and mortgage giant Fannie Mae – can be just as systemically important as a bank. And in 2008, it was just such firms that received the biggest bailouts. Size limits on banks would have done nothing to prevent this.

Rather than trying to prevent failure by chopping up banks, regulators should focus on establishing bankruptcy laws to allow such institutions to fail without undue damage to the economy.

Breaking up banks is a simple answer to a complex problem. And like many simple answers, it is the wrong one, likely to do much harm for little or no benefit. "Too big to fail" should be ended, but breaking up banks is not the way to do it.

James Gattuso

About James Gattuso Senior Research Fellow in Regulatory Policy at the Heritage Foundation

Tags
banking
economy
financial regulation

Other Arguments

#2
24 Pts
The Largest U.S. Banks Can Still Cause a Disaster

Yes – The Largest U.S. Banks Can Still Cause a Disaster

Simon Johnson Senior Fellow at the Peterson Institute for International Economics

#4
13 Pts
There's No Downside to Breaking Up Banks

Yes – There's No Downside to Breaking Up Banks

Dean Baker Codirector of the Center for Economic and Policy Research

#6
-19 Pts
Re-Engineer Banks, Don't Break Them Up

No – Re-Engineer Banks, Don't Break Them Up

Allan D. Grody President of Financial InterGroup Holdings Ltd.

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