Simon Johnson is happier than I expected he'd be with the Dodd-Frank financial reform bill:
A Roosevelt Moment for America’s Megabanks?, by Simon Johnson, Commentary, Project Syndicate: Just over a hundred years ago, the United States led the world in terms of rethinking how big business worked – and when the power of such firms should be constrained. In retrospect, the breakthrough legislation ... was the Sherman Antitrust Act of 1890. The Dodd-Frank Financial Reform Bill, which is about to pass the US Senate, does something similar – and long overdue – for banking.
Prior to 1890, big business was widely regarded as more efficient and generally more modern than small business. Most people saw the consolidation of smaller firms into fewer, large firms as a stabilizing development that rewarded success and allowed for further productive investment. The creation of America as a major economic power, after all, was made possible by giant steel mills, integrated railway systems, and the mobilization of enormous energy reserves through such ventures as Standard Oil.
But ever-bigger business also had a profound social impact, and here the ledger entries were not all in the positive column. The people who ran big business were often unscrupulous, and in some cases used their dominant market position to drive out their competitors – enabling the surviving firms subsequently to restrict supply and raise prices. ... Big business brought major productivity improvements, but it also increased the power of private companies to act in ways that were injurious to the broader marketplace – and to society.
The Sherman Act itself did not change this situation overnight, but, once President Theodore Roosevelt decided to take up the cause, it became a powerful tool that could be used to break up industrial and transportation monopolies. By doing so, Roosevelt and those who followed in his footsteps shifted the consensus. ...
Why are these antitrust tools not used against today’s megabanks...? The answer is that the kind of power that big banks wield today is very different from what was imagined by the Sherman Act... The banks do not have monopoly pricing power in the traditional sense, and their market share – at the national level – is lower than what would trigger an antitrust investigation in the non-financial sectors. ...
Now, however, a new form of antitrust arrives – in the form of the Kanjorski Amendment, whose language was embedded in the Dodd-Frank bill. Once the bill becomes law, federal regulators will have the right and the responsibility to limit the scope of big banks and, as necessary, break them up when they pose a “grave risk” to financial stability. ...
Representative Paul Kanjorski ... recently [said], “The key lesson of the last decade is that financial regulators must use their powers, rather than coddle industry interests.” ... Regulators can do a great deal, but they need political direction from the highest level in order to make genuine progress. Teddy Roosevelt, of course, preferred to “Speak softly and carry a big stick.” The Kanjorski Amendment is a very big stick. Who will pick it up?
One argument against breaking up large banks, one I've given myself, is that it won't necessarily eliminate systemic risk. A shock that pushes a large bank into bankruptcy could just as easily cause a large number of smaller firms engaged in the same business to fail. This could create just as much trouble for the financial system as the failure of a single bank encompassing the smaller entities. In fact, it could be even harder for regulators to figure out how to address the failure of, say, one hundred small firms rather than just one large firm. Thus, breaking up large banks may do little to reduce systemic risk, but, as the argument goes, there is a chance that efficiency will fall. If so, then this is not a good policy.
But I think there are several counterarguments to this. First, there maybe some shocks that would take a single, large bank down, but might not do the same to the smaller banks derived from it. The key here is that the smaller banks pursue diversified strategies so that only some of them are vulnerable to a particular type of shock. If they all do the same thing as the large bank did before it was broken up, then they will still face common risks. However, even so, I'd still worry that there is not that much safety from braking banks up, i.e. that most shocks that would take down large banks will also take down enough small banks to create similar problems. So it's not clear to me that the benefit from breaking banks up to reduce systemic risk is very large.
But what about the costs? The second point is that the question of the efficient scale for banks has never been satisfactorily addressed so far as I can tell. How much efficiency would be lost if we cut the largest bank into two independent pieces? If the answer is zero, or very little, then we should break these banks up. After all, their large size gives them considerable political clout, enough that they have the ability to influence legislation and regulation on their behalf. That gives large banks an economic advantage that they shouldn't have. If there is no cost to breaking them up, and if it helps to reduce their economic and political power, power that gives then an advantage over their smaller rivals, then we should do so.
Third, I am not convinced that traditional antitrust law could not have been applied in many instances. I fully agree that existing anti-trust law was not comprehensive enough, and that new legislation was needed. But I also believe that some markets were highly concentrated economically so that traditional law would have applied, and that this concentration was the source of the systemic risk (AIG and insurance markets come to mind here).
This is why I think the point about leadership is essential. We have been through several decades where the prevailing attitude among those with the power to affect pubic opinion and, more importantly, to affect the enforcement of anti-trust law was that markets could take care of themselves. The build up of market power was not something to worry about, market forces would solve the problem, or so it was believed. This belief allowed economic power and the political power that comes with it to become far too concentrated, and market forces did not counteract this tendency. The power is now entrenched and difficult to dislodge. We need leadership to change this, and if the financial sector is the opening salvo in that effort, I'm all for it. But I suspect the actual implementation of both new and old laws designed to curtail economic and political power will, in the end, come up far short of what many of us are hoping for.