Increasingly, leading bankers repeat versions of the argument made recently by E. Gerald Corrigan in his Dolan Lecture at Fairfield University. Corrigan, former President of the New York Fed and a senior executive at Goldman Sachs for more than a decade, makes three main points.
(1) “Large Integrated Financial Groups”--at or around their current size--offer unique functions that cannot otherwise be provided. The economy needs these groups.
(2) Breaking up such groups would be extremely complex and almost certainly very disruptive.
(3) An “Enhanced Resolution Authority” can mitigate the problems that are likely to occur in the future, when one or more group fails.
These assertions are all completely wrong.
Gerry Corrigan’s first claim (p.4), that Large Groups are indispensable, is completely at odds with the data. The current size of our biggest financial firms is a recent phenomenon. In 1998, when Corrigan already worked there, Goldman Sachs was roughly ¼ of its current size and was regarded a top international investment bank.
More generally, in the mid-1990s today’s big six “Large Integrated Financial Groups” added together had assets worth less than 20 percent of GDP--with no bank being larger than 4 percent of GDP (including off-balance sheet liabilities). Today, these six are over 60 percent of GDP combined and still growing.
What has changed for the better in the functioning of our financial system, in how it assists the real economy, or in how it facilitates government fiscal policy since the mid-1990s?
The financial system worked fine (not great, but fine) in the mid-1990s. It should be rolled back to that level. Hard size caps, as a percent of GDP, are the way to achieve this (e.g., no high-rolling investment bank can exceed 2% of GDP; no boring commercial bank can be bigger than 4% of GDP).
Corrigan’s second claim, that breaking up banks would be hard to do, is based on assessing a “straw man” proposal--that the government dictate the microstructure of any bank downsizing. But no one serious has put forward such an idea.
A hard size cap for total assets would operate just as the hard cap (10%) on share of total retail deposits was envisaged by the Riegle-Neal Act. The bank itself is responsible for complying with this regulation, subject to supervision by the authorities.
If any bank complies with any regulation in a way that reduces shareholder value, its shareholders are going to be very upset. Goldman Sachs is filled to the brim with smart people; they can figure this out.
Corrigan’s final claim, that an Enhanced Resolution Authority can deal with the manifest problems of Too Big To Fail, is simply wishful thinking.
It is a fantasy to think that any national Resolution Authority would make a difference. All banking experts, when pressed, agree that you need to have a cross-border Resolution Authority in order to deal with the failure of a Large International Integrated Financial Group. Show me the G20 process in place or any other international initiative that can achieve this faster than in 20 years. (I made this point recently to leading financial officials; one of the most influential people present said, in effect, “it will never happen”.)
At moments in his speech, Corrigan is brutally honest.
“First; it is inevitable that at some point in the future, asset price bubbles, financial shocks and seriously troubled financial institutions will again occur.” (p.6)
“Unfortunately, events--and not only those associated with the current crisis--have graphically illustrated that the threat associated with financially driven systemic risk has not diminished but has sharply increased [since 1987]” (p.7)
But if you combine that blunt assessment with his policy prescription, what do you get? Our top bankers are publicly and blatantly proposing the recipe for repeated debilitating bailouts. This is an anti-growth and anti-jobs agenda.