Anybody who reads this blog with some frequency will notice that I in general am a big fan of blogger Matt Yglesias and his work. That said, I have some deep disagreements with him about his latest article about bank dividends.
The final paragraph really sums up some of the concerns he has been blogging about in regards to the solvency of the finance industry.
But my point—following Admati and Hellweg—is that regulators shouldn’t just look over JP Morgan’s shoulders and second-guess its investment decisions. Regulators shouldn’t let JP Morgan go so deeply into debt. Or, rather, given that JP Morgan is already deeply in debt they should make it get out of debt. Which shouldn’t be difficult. JP Morgan is profitable. Those profits can be used to pay dividends to JP Morgan shareholders. But they could also be used to reduce JP Morgan’s level of indebtedness. Then JP Morgan managers would be playing less with creditors’ money and more with shareholders’ money. That would make it much less likely that any given bad trade would lead to a bankruptcy scenario. It would let us worry less about second-guessing JP Morgan’s trades, and just be more confident that whether or not they screw up the financial system can stay strong and steady. And contrary to banker myth, blocking banks from becoming so indebted wouldn’t reduce their ability to lend—it would reduce their ability to return profits to shareholders.
Yglesias wishes that regulators (the OCC the CFPB or the FDIC) could force a bank to become less indebted. Except that they already do this!
Banks can be issued issued things called, “consent orders“. Basically what these do is state to the public that the offending bank has been notified that it’s behavior in lending or management of funds has been outside the accepted practice for a lending institution, and that they have a certain amount of time to complete a redress of these offenses. In the most severe cases, banks are banned from providing new credit to borrowers until their existing booked loans are up to snuff. That the regulatory bodies of the United States chose not to do this with JP Morgan is an entire issue in it’s own right; however, let’s not act as though those powers are not totally within the wheelhouse of the regulatory officials.
Further, in my opinion, there are ‘banks’ and then there are ‘Banks’. (notice the capitalization). Small instituions like thrifts (formerly saving and loan associations) or small commercial banks should be talked about differently than the larger ‘Banks’, ie JP Morgan, Wells, BofA et al. Larger banking houses tend to have a larger portfolio and balance sheet because they use many more financial tools and do much more trading with much more sophisticated instruments that require a lot of supervision (hence the OCC).
Whereas, if a small commercial bank, “Mom & Pop Local Bank” as Yglesias uses in his example, were to give out dividends to stock owners of the bank, and the bank is in a reasonably healthy position then why shouldn’t it make use of the extra cash on hand. Part of keeping the confidence of investors to me seems that investors like knowing they’ll get at least the money they put in the bank back, but that they see a return on that investment. Otherwise, why put the cash in banks at all? Why not invest in another company or industry? Because returns on stock bolsters confidence. Granted, banks shouldn’t always do this, regardless of size, but to be opposed in principle of the idea that people don’t get a dividend despite investing seems a little off to me.