Big Banks Are Hazardous to U.S. Financial Health

Sept. 3 (Bloomberg) -- The debate over whether the U.S.’s largest banks are too big is heating up. Since the 2008 financial crisis, the perception has taken hold among some analysts and economists that certain U.S. institutions are too big to fail, meaning they would have to be bailed out to protect the financial system in the event of another calamity.

The recent trading losses at JPMorgan Chase & Co. and scandals over money laundering at HSBC Holdings Plc and Standard Chartered Plc have prompted even financial-industry insiders to ask whether these complex global organizations are too big to manage.

The continued downward spiral in Europe raises a similar question: Are some banks too big to save, meaning their collapse could dramatically worsen the euro crisis (as happened in Ireland in the fall of 2008 and is happening now in Spain and Greece)?

The critics must be gaining converts because, in recent weeks, the defenders of large banks have started to push back. William B. Harrison Jr., the former chairman of JPMorgan, and Wayne Abernathy, the executive vice president of the American Bankers Association, both wrote op-eds that argue against breaking up banks. The Financial Services Roundtable, a large-bank lobby group, has circulated two e-mails insisting that the critics’ arguments are based entirely on myths.

Three Claims

The big-bank proponents make three main claims about bank size; none is convincing when one considers the facts.

First, Harrison argues that growth in banks’ size in recent decades was purely market-driven, in the sense that no government subsidies were (or are) involved. He neglects to mention that this growth is largely a much more recent phenomenon.

In 1995, the Big Six -- JPMorgan, Bank of America Corp., Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc. and Morgan Stanley -- had assets worth only 17 percent of U.S. gross domestic product. As recently as 2005, their collective balance sheets were valued at less than 50 percent of GDP.

Today, the Big Six are much bigger, with combined assets of 60 percent of GDP. Their size, relative to the economy, isn’t as great as that of some German and U.K. banks, but that doesn’t mean the U.S. is safer -- only that Europe’s problem is worse. Ironically, the biggest U.S. banks got even bigger, and more dangerous, through acquisitions and government-encouraged mergers in the 2008 crisis.

Harrison and the others claim that the increase in bank size is driven by the demands of international trade in general and the specific needs of large, globe-spanning corporate clients. But international trade boomed for many years after World War II without bank sizes increasing relative to the size of the U.S. economy.

When I talk to executives at multinational companies, they stress the need to buy financial services from a number of providers. It wouldn’t be good business practice, they say, to rely too much on one megabank. Bond issues, loans, payment processing and other financial services are handled across multiple banks.

The big development since 1995 had little to do with global trade and a lot to do with deregulation, which resulted from intense lobbying by powerful financial figures such as Sanford Weill, the former Citigroup chief executive officer. Weill championed the repeal of the Depression-era Glass-Steagall Act that separated investment banking from depository institutions, allowing him to create Citigroup as a banking supermarket. But Weill in July said he now believes investment banks should be kept separate from commercial banks.

Big Six

Besides, does anyone seriously think that any administration would allow another Lehman-type failure? Lehman Brothers Holdings Inc. had assets of about $640 billion when it went bankrupt; Bear Stearns Cos. was slightly smaller at its peak. All of the Big Six are currently larger than either investment bank was when it failed.

Due to this implicit protection, most analysts estimate that too-big-to-fail banks can borrow for about 50 basis points, or 0.5 percentage point, less than financial firms that aren’t effectively backed by the government.

The bigger these subsidized institutions become, the more likely they are to receive government support in times of distress. Implicit subsidies increase as the systemic importance of a bank rises, creating more incentive for management to talk up the social value of their bank becoming even larger.

All of this is really about privatizing the benefits when things go well and socializing the costs when things go poorly. No one has found measurable economies of scale or scope for banks with more than $100 billion in total assets, yet four of the Big Six have balance sheets exceeding $1 trillion. Global megabanks have become a huge, nontransparent and dangerous government-subsidy program.

Second, the Financial Services Roundtable baldly states that the U.S. doesn’t have the largest banks in the world.

This isn’t true if we do the comparison properly. Under U.S. accounting rules, JPMorgan has a balance sheet with slightly more than $2 trillion in assets. As I explained in an earlier column, several non-U.S. banks are larger but they use international accounting standards, which don’t allow as much “netting” of derivatives positions as U.S. accounting rules do. Netting allows banks to report smaller liabilities on their balance sheets.

My colleague at Massachusetts Institute of Technology, John Parsons, and I converted JPMorgan’s balance sheet to international rules and found that the assets would grow to almost $4 trillion. Measured this way, JPMorgan and Bank of America are the largest banks in the world, and at least 50 percent larger than their nearest non-U.S. rivals.

Third, the roundtable points out that some other countries’ banks are bigger as a percentage of their domestic economies than is the case in the U.S.

Excessive Risks

This is true, but think about the problems some European countries have encountered because of the excessive risks their banks took: Iceland’s economy collapsed and needed an international bailout; Ireland rescued its banks but the fiscal disaster that followed ended in a bailout; and Spain, in a downward spiral at the moment, is seeking a bailout for its banks.

Large financial institutions in countries such as Greece, Italy and France pose a systemic risk to their governments -- and perhaps to the euro area, as well.

Do you really think big banks have been well-managed in Japan or Germany? Look at the exposure of German banks to troubled euro-area governments. And please don’t bring up Canada unless you are willing to discuss the full panoply of government support provided to its banks in general and during the 2008-09 crisis, in particular. Even Switzerland, sometimes synonymous with the phrase “powerful banker,” is trying to get its largest banks, UBS AG and Credit Suisse Group AG, to scale back and reduce the risks they pose to Swiss taxpayers.

None of these countries offers an appealing model for the U.S., which should go in the other direction and roll back recent increases in bank size. The U.S. nonfinancial sector worked fine in the mid-1990s, including its ability to run global supply chains and to generate productivity increases.

The U.S. should make its largest banks small and simple enough to fail without government or central-bank intervention. End their subsidies now.

(Simon Johnson, a professor at the MIT Sloan School of Management as well as a senior fellow at the Peterson Institute for International Economics, is co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.” The opinions expressed are his own.)

Read more opinion online from Bloomberg View. Subscribe to receive a daily e-mail highlighting new View editorials, columns and op-ed articles.

Today’s highlights: the editors on unglamorous but successful job-creation programs and on the latest Iran nuclear report; Albert R. Hunt on Barack Obama’s second-term persona; Simon Johnson on the perils of big banks; Pankaj Mishra on the rebirth of the Nonaligned Movement.

To contact the writer of this article: Simon Johnson at

To contact the editor responsible for this article: Paula Dwyer at

    Before it's here, it's on the Bloomberg Terminal.