Tyler Cowen of the blog Marginal Revolution has an op/ed in todays New York Times concerning the growing calls for the government to step in and break up banks that have been called “Too Big To Fail”.


…the logic of cutting down huge institutions could mean splitting the largest ones into several pieces. Yet banks do not always come in easily divisible parts. Such a move could amount to eradicating the largest banks rather than splitting them up — and eradication is both politically unlikely and potentially disastrous for the economy. In short, if the resulting parts of a divided bank cannot turn a profit, the split-up may prompt the very bailout it was trying to avoid.

Cowen then goes on to cite a recent paper written by Eugene White of Rutgers. White succinctly summarizes the last century of bank runs and growth of government legislation to curb excess.

White closes his paper with the following point:

The most common argument is that banking is far more complex than in the nineteenth century. Yet, its very complexity is an outcome of the efforts to regulate the choices that banks, with management and skilled professionals designing new instruments and trading procedures to circumvent the rules.

People in my life have said that I have a very pessimistic view of the innate  good of my fellow human beings. Probably because of this, I disagree with Cowen and White on a great many of their points. I do agree that regulations are becoming unwieldy and will likely come to a point where they completely hinder the growth of capital.

Cowen contends that rather than putting our faith in the central bank or a regulatory agency, extending the liability on bank shareholders would be the best course of action.

Money quote:

Expanded liability for bank shareholders might satisfy the Occupy Wall Street movement, and could be sold as a market-oriented, not regulatory solution; it’s probably what markets would insist upon if there were no central bank and no F.D.I.C. As recently as the 1980s, the partnership structure, another alternative to limited liability, was common among investment banks — and that hardly seemed a crippling drawback at the time.


Cowen writes well, it is obvious that he has spent a great amount of time studying this subject. I feel it neccesary to reply in two points, however. First, I do not agree that purely because breaking up a bank is hard and  requires time and effort it should be discounted. I am sure that a great many industrialists said the same thing of US Steel or Standard Oil.

Secondly, the argument that shareholders and a proper risk management department are preferred to a regulatory agency may make bank’s feel like they’re more liable, but they’re really not. Supposing that the shareholders form together on an ill-advised path that makes them a great amount of money, but ends up closing the bank and losing a lot of non-shareholders their money in the bank? Who speaks for the consumer?

The continuing necessity for a bank insurance agent (the FDIC) will always be neccesary in a competitive banking environment and while we can debate the merits of regulatory reform, the safety that the FDIC has provided to the consumer has arguably driven average investment in the very banks that Cowen and White would seek to self-regulate.