The Economy Cannot Recover Until the Big Banks Are Broken Up → Washingtons Blog
The Economy Cannot Recover Until the Big Banks Are Broken Up - Washingtons Blog

Saturday, December 11, 2010

The Economy Cannot Recover Until the Big Banks Are Broken Up

A lot of people still haven't heard that the economy cannot recover until the big banks are broken up.

But virtually all independent economists and financial experts say that it is vital to break up the giant banks, including:

  • Dean and professor of finance and economics at Columbia Business School, and chairman of the Council of Economic Advisers under President George W. Bush, R. Glenn Hubbard
  • The leading monetary economist and co-author with Milton Friedman of the leading treatise on the Great Depression, Anna Schwartz
  • Economics professor and senior regulator during the S & L crisis, William K. Black
  • Professor of entrepreneurship and finance at the Chicago Booth School of Business, Luigi Zingales

Why do these experts say the giant banks need to be broken up?

Well, small banks have been lending much more than the big boys. The giant banks which received taxpayer bailouts have been harming the economy by slashing lending, giving higher bonuses, and operating at higher costs than banks which didn't get bailed out.

As Fortune pointed out, the only reason that smaller banks haven't been able to expand and thrive is that the too-big-to-fails have decreased competition:

Growth for the nation's smaller banks represents a reversal of trends from the last twenty years, when the biggest banks got much bigger and many of the smallest players were gobbled up or driven under...

As big banks struggle to find a way forward and rising loan losses threaten to punish poorly run banks of all sizes, smaller but well capitalized institutions have a long-awaited chance to expand.

So the very size of the giants squashes competition, and prevents the small and medium size banks to start lending to Main Street again.

And as I noted in December 2008, the big banks are the major reason why sovereign debt has become a crisis:

The Bank for International Settlements (BIS) is often called the "central banks' central bank", as it coordinates transactions between central banks.

BIS points out in a new report that the bank rescue packages have transferred significant risks onto government balance sheets, which is reflected in the corresponding widening of sovereign credit default swaps:

The scope and magnitude of the bank rescue packages also meant that significant risks had been transferred onto government balance sheets. This was particularly apparent in the market for CDS referencing sovereigns involved either in large individual bank rescues or in broad-based support packages for the financial sector, including the United States. While such CDS were thinly traded prior to the announced rescue packages, spreads widened suddenly on increased demand for credit protection, while corresponding financial sector spreads tightened.
In other words, by assuming huge portions of the risk from banks trading in toxic derivatives, and by spending trillions that they don't have, central banks have put their countries at risk from default.

A study of 124 banking crises by the International Monetary Fund found that propping banks which are only pretending to be solvent hurts the economy:

Existing empirical research has shown that providing assistance to banks and their borrowers can be counterproductive, resulting in increased losses to banks, which often abuse forbearance to take unproductive risks at government expense. The typical result of forbearance is a deeper hole in the net worth of banks, crippling tax burdens to finance bank bailouts, and even more severe credit supply contraction and economic decline than would have occurred in the absence of forbearance.

Cross-country analysis to date also shows that accommodative policy measures (such as substantial liquidity support, explicit government guarantee on financial institutions’ liabilities and forbearance from prudential regulations) tend to be fiscally costly and that these particular policies do not necessarily accelerate the speed of economic recovery.


All too often, central banks privilege stability over cost in the heat of the containment phase: if so, they may too liberally extend loans to an illiquid bank which is almost certain to prove insolvent anyway. Also, closure of a nonviable bank is often delayed for too long, even when there are clear signs of insolvency (Lindgren, 2003). Since bank closures face many obstacles, there is a tendency to rely instead on blanket government guarantees which, if the government’s fiscal and political position makes them credible, can work albeit at the cost of placing the burden on the budget, typically squeezing future provision of needed public services.
Now, Greece, Portugal, Spain and many other European countries - as well as the U.S. and Japan - are facing serious debt crises. We are no longer wealthy enough to keep bailing out the bloated banks. See this, this, this, this, this and this.

Indeed, the top independent experts say that the biggest banks are insolvent (see this, for example), as they have been many times before. By failing to break up the giant banks, the government will keep taking emergency measures (
see this and this) to try to cover up their insolvency. But those measures drain the life blood out of the real economy.

And by failing to break them up, the government is guaranteeing that they will take crazily risky bets again and again, and the government will wrack up more and more debt bailing them out in the future.
(Anyone who thinks that Congress will use the current financial regulation - Dodd-Frank - to break up banks in the middle of an even bigger crisis is dreaming. If the giant banks aren't broken up now - when they are threatening to take down the world economy - they won't be broken up next time they become insolvent either. And see this. In other words, there is no better time than today to break them up).

Moreover, Richard Alford - former New York Fed economist, trading floor economist and strategist - recently showed that banks that get too big benefit from "information asymmetry" which disrupts the free market.

Indeed, Nobel prize-winning economist Joseph Stiglitz noted in September that giants like Goldman are using their size to manipulate the market:

"The main problem that Goldman raises is a question of size: 'too big to fail.' In some markets, they have a significant fraction of trades. Why is that important? They trade both on their proprietary desk and on behalf of customers. When you do that and you have a significant fraction of all trades, you have a lot of information."

Further, he says, "That raises the potential of conflicts of interest, problems of front-running, using that inside information for your proprietary desk. And that's why the Volcker report came out and said that we need to restrict the kinds of activity that these large institutions have. If you're going to trade on behalf of others, if you're going to be a commercial bank, you can't engage in certain kinds of risk-taking behavior."

The giants (especially Goldman Sachs) have also used high-frequency program trading which not only distorts the markets - making up more than 70% of stock trades - but which also lets the program trading giants take a sneak peak at what the real (that is, human) traders are buying and selling, and then trade on the insider information. See this, this, this, this and this. (This is frontrunning, which is illegal; but it is a lot bigger than garden variety frontrunning, because the program traders are not only trading based on inside knowledge of what their own clients are doing, they are also trading based on knowledge of what all other traders are doing). Goldman also admitted that its proprietary trading program can "manipulate the markets in unfair ways".

Moreover, JP Morgan Chase, Bank of America, Goldman Sachs, Citigroup, and Morgan Stanley together hold 80% of the country's derivatives risk, and 96% of the exposure to credit derivatives. Experts say that derivatives will never be reined in until the mega-banks are broken up - and see this - even though the lack of transparency in derivatives is one of the main risks to the economy.

The giant banks have also allegedly used their Counterparty Risk Management Policy Group (CRMPG) to exchange secret information and formulate coordinated mutually beneficial actions, all with the government's blessings.

Again, size matters. If a bunch of small banks did this, manipulation by numerous small players would tend to cancel each other out. But with a handful of giants doing it, it can manipulate the entire economy in ways which are not good for the American citizen.

In addition, as everyone from Paul Krugman to Simon Johnson has noted, the banks are so big and politically powerful that they have bought the politicians and captured the regulators. So their very size is preventing the changes needed to fix the economy.


  1. I saw this on the Internet. Too big to jail as opposed to too big to fail.

    I would like to point out something serious that will ruin America in months.

    The November Deficit Was 205 Billion Dollars.

    I saw a piece by Karl Denninger and mindful of Zero Hedge's ongoing series telling us that the deficit is way less than the amount the Treasury borrows I decided to check for myself at

    I input the dates 10-31-2010 and 11-30-2010 as Denninger did to see the growth in debt. When I looked at TOTAL DEBT HELD BY THE PUBLIC I GOT AN INCREASE FROM 9,069,879,047,803.52 TO 9,275,024,690,843.88.

    I said Holy Cow. The real deficit is more than 205 billion dollars a month.

    Let me explain why the Debt Held By Public figure is more relevant than the total which includes debt held by Social Security and other agencies. As I explained in high school discussions, Social Security surpluses are not real. They buy bonds which they will sell when the Baby Boomers retire. Then the Treasury will sell bonds to the public to give to Social Security to pay the retirees.

    We are now in that period where Social Security will be redeeming the 4.5 trillion dollars they hold in US bonds.

    Ben Bernanke will have to print at least 200 billion a month in new money to keep the Federal government running. Plus he has to buy back trillions of dollars in fraudulent mortgages American banksters have sold around the world.

    I don't think Bernanke can do this much longer.

    Paul Craig Roberts in his latest interview with Max Keiser said that the IMF is controlled by the big banks and that they will use the IMF to force austerity on America just they did to Ireland.

  2. As Kevin Phillips has pointed out in several books since Wealth and Democracy, including Bad Money, the elites of the Spanish, Dutch, and English empires all proved incapable of reforming themselves. This doesn't bode well for our current situation.

    Rather than fix the structural problems, elites continue to enrich themselves at everyone else's expense. They won't permit reform because of their greed and ideological stupidity. They prefer capital flight to a balanced current account. They will never admit that flat earth, "laissez faire," deregulated, crony capitalism is just a manifestation of their greed and denial. They are as decadent as the ancien regimes of Europe. Next we'll be hearing of the "Divine Right of Investment Bankers."

  3. Lobby your state, county, and municipal governments to have them stop banking with the giants. That would suck a lot of cash out of the TBTFs. Government deposits at risk were probably used to blackmail congress into approving the bailout.

    If we ever get to where members of congress act as public servants, rather than bank servants, we need to institute demand deposit banking as a public service for a reasonable price. Let people lend and invest their own damn money.

    We should also go to a multi-metallic backed currency, say Cu, Ni, Ag, Au, Pt. We should mint coins in those metals and get rid of paper money. How many of us still carry cash anyway? Get rid of the Fed and make price stability the priority.

    Our 17th century finance system is looting the world because the world is waking up to the fact that the system is no longer relevant. Your phone probably has enough computing power to replace most of the services that once made that system necessary.

  4. Allow me to sum it up in 4 words.
    Concentrated wealth destroys democracies.

  5. There is nothing healthy or ethical in concentrated wealths. It has always been that way through the entire history of man. Even literature which is based on the times periods of the written bears that out. History and stats give us what happened and why. Literature clearly shows the effects and results to the ordinary citizens of any nation.

  6. “Ben Shalom Bernanke is wanted for violating the United States Constitution, committing acts of financial terrorism and crimes against humanity. As a leading member of the Global Banking Cartel, he is considered a highly dangerous enemy combatant. Citizens of the United States hereby demand that he be properly detained under the laws and customs of war.”

    One secret divulged by the Fed lately is the secret 12.3 trillion world bank bailout. There are trillions more that they are not telling us about. Were Dead! Audit the Fed!

  7. I agree with all of you except for one little difference with Windcatcher, "WE'RE DEAD" NOT! THEY'RE DEAD (the central bankers of the world) as all the debt in bogus monies they've created to loan every barely breathing Tom, Dick, and Harry has been of the bankers own making out of Thin Derivital Digital Strokes (TDDS), soooooooooo, when the chickens come home to roost, they'll find they're all roosters and get no eggs! I guess they'll try to boil 'em in a pot for dinner, but my intuition tells me they'll be pretty dry & stringy fare. And there's only so many of them to go around, what'll they do? What WILL they do?

    It's going to be an interesting year, get out the popcorn and enjoy the coming attractions before the show.

  8. Musemater: When I said “Were Dead”, I was referring to our Democracy, Independence (sovereignty) and our Individual Rights under law as Americans (by law, we are enslaved to national debt) which has been overthrown by the Fascist World Banking Cartel.

    Americans were helpless spectators as the banksters moved their American industry and technology assets to China. Caterpillar and General Motors are Chinese Communist corporation’s not American corporations. Get it; China is their new home where the chickens roost and Communism is their new government ideal with a slight twist. That is why China will soon be number one, American industry and technology has been sacked by the banksters.

    Think about it like an economist, what could be better then total control of resources and people in the world by an untouchable banking world power dictated from the Totalitarian board room and those dictates are enforced by the largest army in the world with 3 million soldiers- NATO.

    Americans are spectators to their own execution. Banksters consider people who will not or can not pay debt forever to them as “Human Garbage”. You have seen news clips of Fascist marching obedient people to an open pit, lining them up, (Don’t forget the popcorn!) then shooting them.

    Today, the Fascist World Banking Cartel plan is winning with debt, we have no choice, and we are in so deep in debt to them we can’t get out. Modeled after the Nazi Fascist, there is little difference; both have the same psychopathic world power and control delusion.

  9. All these big smart people jumping in the front of the line saying "trust is important". WOW!
    That was something the rest of us learned when we were little children. WE did not need a global economic crises to realize that. This may read like a criticism of a certain class of people. IF THEY HAVE BRAINS WHY DID THEY NOT SAY THIS WHEN EVEN CHILDREN WERE SAYING IT 2000 YEARS AGO!? Bankers and financial institutions have been doing their crimes since the #^*%$^&%(* FALL OF ROME! Since the financial collapse rigged by Venice in 1345! President Andrew Jackson explained clearly the criminal activities of bankers in this country in 1832! There is absolutely NO EXCUSE for the lives of millions, NO, BILLIONS of people to be ruined once again by central bankers and financial institutions. They ARE ALWAYS SCHEMING TO CHEAT PEOPLE! And NOW critics are saying trust is important? Did any of them notice all through recorded history that TRUST has ALWAYS been IMPORTANT? IDIOTS!

  10. Financial Treason!

    Consider the damage done by Wall St. banksters. After the 1929 crash and Great Depression, safeguards were put in place so it could never happen again.

    Wall St. bribed congress to kill the safeguards protecting the American people.

    9 yrs later the same thing happens, the crash of 2008 followed by the mess we are going through now, and it's not done yet.

    Totally premeditated by greedy people with lots of money who don't care what happens to the rest of us as long as they get theirs.

  11. Banking is necessary. Like government. Necessary services especially may be subject to corruption.

    But people need to remember that the United States is still the richest country in the world.

    Our debt has been much worse in the past.

    We still have a credit card that works. The question is what we are going to spend the money on.

    You don't expel your kids from college cause it puts you into debt. You just make sure they're getting what they need to get out of the experience!

    Let's not go crazy here, peeps.


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