The Bill Daley Problem is Completely Bipartisan

Top bankers, like Mr. Daley’s former colleagues, are intent on becoming more global — despite the fact that (or perhaps because) we cannot handle the failure of massive global banks. Today’s most dangerous government sponsored enterprises are the largest six bank holding companies: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley.

The Bill Daley Problem

January 9, 2011

Economist's View - Simon Johnson discusses how Obama's choice of Bill Daley to be his Chief of Staff might impact his views on "a huge time bomb," the continued existence of too big to fail banks:

The Bill Daley Problem, by Simon Johnson: Bill Daley, President Obama’s newly appointed chief of staff, is an experienced business executive. By all accounts, he is decisive, well-organized, and a skilled negotiator. His appointment, combined with other elements of the White House reshuffle, provides insight into how the president understands our economy — and what is likely to happen over the next couple of years. This is a serious problem.

This is not a critique from the left or from the right. The Bill Daley Problem is completely bipartisan — it shows us the White House fails to understand that, at the heart of our economy, we have a huge time bomb.

Until this week, Bill Daley was on the top operating committee at JP Morgan Chase. His bank — along with the other largest U.S. banks — have far too little equity and far too much debt relative to that thin level of equity; this makes them highly dangerous from a social point of view. These banks have captured the hearts and minds of top regulators and most of the political class (across the spectrum), most recently with completely specious arguments about why banks cannot be compelled to operate more safely. Top bankers, like Mr. Daley’s former colleagues, are intent on becoming more global — despite the fact that (or perhaps because) we cannot handle the failure of massive global banks. ...

Today’s most dangerous government sponsored enterprises are the largest six bank holding companies: JP Morgan Chase, Bank of America, Citigroup, Wells Fargo, Goldman Sachs, and Morgan Stanley. They are undoubtedly too big to fail — if they were on the brink of failure, they would be rescued by the government, in the sense that their creditors would be protected 100 percent. The market knows this and, as a result, these large institutions can borrow more cheaply than their smaller competitors. This lets them stay big and — amazingly — get bigger.

In the latest available data (Q3 of 2010), the big 6 had assets worth 64 percent of GDP. This is up from before the crisis — assets in the big six at the end of 2006 were only about 55 percent of GDP. And this is up massively from 1995, when these same banks (some of which had different names back then) were only 17 percent of GDP.

No one can show significant social benefits from the increase in bank size, leverage, and overall riskiness over the past 15 years. The social costs of these banks — and their complete capture of the regulatory apparatus — are apparent in the worst recession and slowest recovery since the 1930s.

Paul Volcker gets it; no wonder he has resigned. ... Gene Fama, father of the efficient financial markets view, gets it better than anyone. I discussed the issue in public for two hours at the American Financial Association (AFA) meetings in Denver on Friday with two presidents of the AFA (Raghu Rajan and John Cochrane) and a Nobel Prize winner (Myron Scholes). This is not a left-wing or marginal group... The top minds in academic finance understand the problem vividly and are articulate about it — there is no rebuttal to the points being made by Anat Admati and her distinguished colleagues.

This is not a left-right issue — again, look at the list of people who co-signed Professor Admati’s recent letter to the Financial Times. This is a question of technical competence. Do the people running the country — including both the executive branch and the legislature — understand economics and finance or not?

If the country’s most distinguished nuclear scientists told you, clearly and very publicly, that they now realize a leading reactor design is very dangerous, would you and your politicians stop to listen? Yet our political leadership brush aside concerns about the way big banks operate. Why?

Top bankers, including Bill Daley, have pulled off a complete snow job... Most smart people in the non-financial world understand that the big banks have become profoundly damaging to the rest of the private sector. The idea that the president needed to bring a top banker into his inner circle in order to build bridges with business is beyond ludicrous.

Bill Daley now controls how information is presented to and decisions are made by the president. Daley’s former boss, Jamie Dimon, is the most dangerous banker in America — presumably he now gets even greater access to the Oval Office. Daley is on the record as opposing strong consumer protection for financial products; Elizabeth Warren faces an even steeper uphill battle. Important regulatory appointments, such as the succession to Sheila Bair at the FDIC, are less likely to go to sensible people. And in all our interactions with other countries, for example around the G20 but also on a bilateral basis, we will pursue the resolutely pro-big finance views of the second Clinton administration.

Let’s be honest. With the appointment of Bill Daley, the big banks have won completely this round of boom-bust-bailout. The risk inherent to our financial system is now higher than it was in the early/mid-2000s. We are set up for another illusory financial expansion and another debilitating crisis.

I've been calling for someone — anyone — to point to evidence of scale economies in banking for some time now so that we can evaluate the costs and benefits of breaking up banks that are too politically powerful to be allowed to fail. However, in all the time this topic has been discussed I've only come across one paper looking directly at this issue, and it is not all that convincing. (I understand that small banks can also pose systemic risk if there is a widespread financial collapse, but the risk is still lower with small instead of large banks, and -- importantly -- eliminating big banks reduces the ability of the banking sector to capture the political process).

I think the null hypothesis ought to be that size is a problem. The potential costs of too big to fail banks are large and well known, and unless there are demonstrable benefits to offset the known costs, there is sufficient basis for breaking the banks up. But yet, with scant evidence of the benefits, but plenty of evidence about the costs, too big to fail banks not only persist, the banks are getting bigger. To me, that speaks directly too regulatory capture, and not in a kind way...

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