“Too Big to Fail”: The Debate

Felix Salmon (over at his new digs at Reuters) and Kevin Drum of Mother Jones are having a back-and-forth over putting a cap on bank size, a longtime hobbyhorse of mine.

Drum raises some good questions on the practical issues involved, like:

So here’s what I wonder: what happens when you have a whole bunch of banks all operating at their maximum allowed size? Do they keep taking in money but just sitting on it? Of course not. Do they essentially shut down, not taking any new customers? What about natural growth among existing depositors? (For that matter, what about natural asset growth?)

Which Salmon dispenses with neatly, noting that banks would become more competitive, not less, if they were smaller:

The first thing that a bank does when it starts bumping up against the cap is to start selling off its assets: that’s why I’m a fan of old-fashioned securitization, where banks genuinely move assets off their balance sheet. Kevin’s worried that securitization only applies to assets and not to liabilities, and he wonders what will happen to bank deposits; I’m less worried about that. But fine, if deposits grow too large, then maybe banks can be allowed to exceed the asset cap so long as they invest excess deposits only in Treasury bills. (Or, to put it another way, if you sell off a bunch of loans, you have to invest the proceeds in Treasuries if your deposit base is greater than the asset cap.)

There are other things banks can do to move excess deposits off their balance sheets: they can move big deposits into externally-managed money-market funds, for instance.

As for banks competing with each other by growing, I simply don’t believe that they do. That was the point of Mike’s post, at Rortybomb: when banks get big they’re less competitive, not more competitive.

This debate is a critical one. I’m glad its underway. I’d like to see more straight-news reporting on the implications.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.