Geithner: We Need Big Banks To Be Even Bigger

“I don’t have any enthusiasm for … trying to shrink the relative importance of the financial system in our economy"

Timothy F. Geithner

According to the man running U.S. economic policy, American banks need to be even bigger in order to take advantage of the ‘financial deepening’ that is anticipated in emerging markets. So, no, Geithner says, don’t shrink the big banks. Make them even bigger.

The problem with this view is that it ignores recent history and all available economic research on bank size. Take the latest study from VoxEU economists for example:

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In recent years, many banks have reached enormous size both in absolute terms and relative to their national economies. By 2008:

  • 12 banks worldwide had liabilities exceeding $1 trillion, and
  • 30 banks had a ratio of liabilities to national GDP higher than 0.5.

Large banks tend to be too big to fail, as their failure would have hugely negative repercussions for the overall economy.

Saving oversized banks, however, may ruin a country’s public finances (Gros and Micossi 2008). Take the example of Ireland; this country provided extensive financial support to its large banks and subsequently had to seek financial assistance from the EU and the IMF in 2010. The public finance risks posed by systemically large banks suggest that such banks should be reduced in size.

Further evidence against big banks can be found from studies on banking technologies. Berger and Mester (1997) estimate the returns to scale in US banking using data from the 1990s, to find that a bank’s optimal size, consistent with lowest average costs, would be for a bank with around $25 billion in assets. Amel et al. (2004) similarly report that commercial banks in North America with assets in excess of $50 billion have higher operating costs than smaller banks. These findings together suggest that today’s large banks, with assets in some instances exceeding $ 1 trillion, are well beyond the technologically optimal scale.

Do we need big banks?, VoxEU

The economists go on to suggest that bank size may be a function of corporate governance and agency problems. Specifically, the larger the bank, the larger the prestige and remuneration for top bank managers. This is true irrespective of whether bank shareholders benefit, meaning this is a classic agency problem where bank managers and bank owners’ interest may diverge. And as we witnessed during the crisis, bank stocks swooned as the system collapsed. But most top bank managers walked away with tens of millions without penalty or sanction. That’s how it has worked up until now.

The economists proffer that banks should be limited not just by regulation, but also by bank levies and corporate governance reform.

Good luck with these suggestions. U.S. economic policy is not heading in that direction:

Geithner hunched his shoulders, pressed his knees together, and lifted his heels up off the ground—an almost childlike expression of glee. “We’re going, like, existential,” he said…

[W]e have to think about the fact that we operate in the broader world,” [Geithner] said. “It’s the same thing for Microsoft or anything else. We want U.S. firms to benefit from that.” He continued: “Now financial firms are different because of the risk, but you can contain that through regulation.” This was the purpose of the recent financial reform, he said. In effect, Geithner was arguing that we should be as comfortable linking the fate of our economy to Wall Street as to automakers or Silicon Valley.

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5 Comments
  1. DavidLazarusUK says

    The problem is that if the banks want to expand abroad they need to shrink domestically. Bigger banks are a bigger danger to the economy. Maybe it will get to the point that the government have no option but to let them fail, as they become too big to save. With higher overseas exposure it could mean that the political risks of bailing out a bank with huge overseas exposure is not worth the risk politically, actually increasing the risk of them failing.

  2. Anonymous says

    The problem is that if the banks want to expand abroad they need to shrink domestically. Bigger banks are a bigger danger to the economy. Maybe it will get to the point that the government have no option but to let them fail, as they become too big to save. With higher overseas exposure it could mean that the political risks of bailing out a bank with huge overseas exposure is not worth the risk politically, actually increasing the risk of them failing.

  3. Anonymous says

    And, is it not in Obama’s hands what happens in the next two years, regarding the growth of these banks?

    Will the public hold him accountable for his position on this, in the next elections.

  4. Anonymous says

    And, is it not in Obama’s hands what happens in the next two years, regarding the growth of these banks?

    Will the public hold him accountable for his position on this, in the next elections.

  5. Anonymous says

    Just what America needs. Bigger banks and more top engineers and mathematicians heading into the financial sector will lead America down the path of prosperity….

    NOT!

  6. Anonymous says

    Just what America needs. Bigger banks and more top engineers and mathematicians heading into the financial sector will lead America down the path of prosperity….

    NOT!

  7. fresnodan says

    Astounding – either Geithner has a religious belief in banking…well, I don’t think he is being paid off. Depite the incredilbe implosion of the market, and failure of the whole system to evaluate risk, he refuses to see it. I know I have had to rethink my beliefs in the “free” market.
    Geithner apparently believes the best way to have dealt with the Titanic disaster was to build more Titanics

  8. Anonymous says

    Astounding – either Geithner has a religious belief in banking…well, I don’t think he is being paid off. Depite the incredilbe implosion of the market, and failure of the whole system to evaluate risk, he refuses to see it. I know I have had to rethink my beliefs in the “free” market.
    Geithner apparently believes the best way to have dealt with the Titanic disaster was to build more Titanics

  9. Edward Harrison says

    I do’t know quite what to make of Tim Geithner’s comments. It’s clear to me that trillion-dollar bank size increases systemic risk and regulatory capture, further increasing risk. What is unclear is whether Geithner makes arguments like these simply because he has been captured or because he doesn’t want to reveal the degree to which the system has been captured. On some level, it doesn’t matter. Geithner acts as a pro-financial services lobbyist within government. He legitimizes the pro-bank view that regulation alone will curb bank excess, which concedes a lot of ground to those lobbying for an unbridled pro-bank view without regulation good.

    Again, this is all very ‘corporatist.’ The whole debate should be like this:

    Position 1: “look, we think business should come first. If you have a toss-up between business and individuals, choose business because that’s what leads to a society’s long-term progress.”

    Position 1a: “look, I have a lot of vested interests in certain business groups. So I am going to lobby on their behalf. Sometimes, I will make up stuff for intellectual cover for lobbying on their behalf. Sometimes I will actually fool myself into believing this stuff. But on the whole, I am looking out for myself and my pals.

    Position 2: “look, there is nothing wrong with business. We live in a capitalist society. The question is what to do when certain business groups gain too much influence and power or become too risky. We need to be addressing this issue if we care about the long-term economic health of our whole society instead of the interests of a narrow group.”

    What Geithner seems to be saying is a variant of position 1. I am saying that position 2 is correct.

  10. Edward Harrison says

    I do’t know quite what to make of Tim Geithner’s comments. It’s clear to me that trillion-dollar bank size increases systemic risk and regulatory capture, further increasing risk. What is unclear is whether Geithner makes arguments like these simply because he has been captured or because he doesn’t want to reveal the degree to which the system has been captured. On some level, it doesn’t matter. Geithner acts as a pro-financial services lobbyist within government. He legitimizes the pro-bank view that regulation alone will curb bank excess, which concedes a lot of ground to those lobbying for an unbridled pro-bank view without regulation good.

    Again, this is all very ‘corporatist.’ The whole debate should be like this:

    Position 1: “look, we think business should come first. If you have a toss-up between business and individuals, choose business because that’s what leads to a society’s long-term progress.”

    Position 1a: “look, I have a lot of vested interests in certain business groups. So I am going to lobby on their behalf. Sometimes, I will make up stuff for intellectual cover for lobbying on their behalf. Sometimes I will actually fool myself into believing this stuff. But on the whole, I am looking out for myself and my pals.

    Position 2: “look, there is nothing wrong with business. We live in a capitalist society. The question is what to do when certain business groups gain too much influence and power or become too risky. We need to be addressing this issue if we care about the long-term economic health of our whole society instead of the interests of a narrow group.”

    What Geithner seems to be saying is a variant of position 1. I am saying that position 2 is correct.

Comments are closed.

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