Break up the Banks?!? Get Real

My apologies to Bernie Sanders, Elizabeth Warren, and Minneapolis Fed president and former TARP director Neel Kashkari, but breaking up America’s largest banks is a really dumb idea.
The reasons each of these three wants to break up the banks are pretty consistent.
Kashkari says: “I continue to think that the largest banks in the country are too big to fail.”
Sanders says: “All you need [to break up the banks] is the secretary of Treasury to determine which banks, if they fail, will cause systemic damage to our economy.”
And from a recent Warren tweet: “5 US banks are big enough that any one could crash the economy again if they failed & weren’t bailed out. It’s a very big deal. It’s scary.”
Obviously, they are all referring to the financial crisis of 2008–9, when America’s biggest banks nearly failed and sent the economy into a tailspin. We all remember how scary that was. And I’m sure we were all plenty pissed off that the government had to step in and provide a few trillion in bailout money and guarantees to keep them, and the economy, afloat.
It’s pretty easy to just blame the banks for the financial crisis. After all, they were the ones that way overleveraged into mortgage-backed securities, even when they knew these securities were not the safe investments they appeared to be. So when mortgage default rates spiked higher, it all came crashing down.
Unfortunately, saying that the financial crisis was all the banks’ fault is just too simplistic. There were many, many culprits that helped grow that house of cards bigger and bigger until the only thing it could do was fall apart.
As far back as the late 1970s, there was a government push to encourage more Americans to become homeowners. In 1995, under president Bill Clinton, banks were required to make a certain number of loans to low-income borrowers. Lending standards were lowered, and not by the banks. Between 2001 and 2006, under George W. Bush, the percentage of mortgage loans that were subprime jumped from 7% to 18%. The Perils of Easy Money 
You could get a mortgage loan with no money down. And then there were the infamous “no-doc” loans, where you didn’t even have to provide proof of your income to get a mortgage loan. There were plenty of stories of low-income people claiming they made $150k to get a big loan making the rounds.
If you remember, housing prices were going up so fast that people fully believed they could buy a house for $300K and sell it for $400K in less than a year…
But then home prices fell, people couldn’t afford their payments, and they walked away, leaving the banks (and Freddie Mac and Fannie Mae) holding the bag.
It should be pretty clear by now that when you make money too easily available, bad things start to happen. Just look at how much student loan debt is out there…
Interest rates were also an issue. Greenspan left rates too low for too long, and that made mortgage loans even more attractive. Plus, it encouraged banks to make riskier loans so they could charge higher interest rates. That’s a big reason why subprime mortgage securities got so popular: banks could make more money.
We could also point to the repeal of the Glass-Steagall Act that allowed deposit-based banks to also become investment banks and trade with deposit money as a big contributor.
As the financial crisis hit, America’s big banks were leverage 30 to 1, on average. That means they had $1 in actual cash for every $30 they had in assets. And please note, that’s not so different than a person putting down a minimal down payment for a house. Inmates Running the Asylum 
So the banks had an asset — the mortgage-backed security — that they still owed a lot of money on. But because these are bonds, they get to be treated like cash. Not to the extent that Treasury bonds are cash, but they could still count the mortgage-backed security as an asset and borrow against it.
Now, with the amount of subprime loans ballooning, and the bigger and bigger interest payments that could come with the mortgage-backed securities, you might wonder why no one said, “Hey banks, maybe it’s not a good idea for you to take on so much leverage and risk?”
Well, the people who are supposed to ask that question are called “bank regulators.” It is their job to make sure banks don’t get too risky. But they didn’t really do their job. Part of the reason they didn’t do their job has to do with the ratings agencies, like Moody’s or Standard & Poor’s.
The ratings agencies were routinely giving mortgage-backed securities very high grades, so they appeared much safer than they actually were. It seems the regulators often took the ratings agencies’ rankings as gospel. They literally didn’t know what the mortgage-backed securities actually entailed.
Plus, banks could insure their assets with companies like AIG. So the bank could tell the regulators that they would get paid even if the mortgage-backed securities went bad. AIG wrote hundreds of billions of dollars in insurance policies (called credit default swaps) for banks. And it looked great: AIG made money, the banks looked safe, the regulators didn’t have to work so hard…
To ignore all these factors that contributed to the financial crisis and simply blame the banks is just wrong. If you’re worried that they are engaging in risky behavior, pass laws and get your regulators on it. In fact, we have passed a stronger banking regulation law: Dodd-Frank. New Basel banking regulations require all banks to have more cash on hand to back their assets. And the Federal Reserve now conducts annual stress tests to gauge their health. The Big Scapegoat
In response, bank leverage is down, cash reserves are up, and banks have had to abandon much of their trading activity. There can be no doubt that banks are truly healthier than they were ahead of the crisis.
And besides all that, we actually need big banks. We need large, stable banks that can actually back a billion-dollar line of credit for a corporation. Bank of America, for instance, has $21 billion in energy loans. Something like $8 billion is considered “at risk.” Bank of America is big enough that it can support oil company borrowing needs. And it can weather losses in a way that regional banks simply can’t.
Break the banks up, and big companies could lose an important source of liquidity. (Though actually, it’s likely that foreign banks that hadn’t been broken up would step in to fill the need, taking potential business from U.S. banks.)
Big banks will also have a better ability to lower costs for their customers. It wasn’t your regional bank that started free checking accounts.
Big banks have a greater ability to be geographically diversified. Regional banks in an agricultural area might have greater exposure to farm loans and might be more vulnerable to, say, a bad drought or a natural disaster.
There are a lot of reasons big banks are a good thing. Simply labeling them “too big to fail” and blaming them for the financial crisis ignores the fact that they had a lot of help in bringing down the U.S. economy. But of course, politicians don’t want to admit that…
They don’t want to tell their voters that maybe they got a little greedy with a no-doc loan; they don’t want to admit that maybe they voted for some laws that helped push the housing bubble. They’d much rather make the banks the bad guy, pander to you about how you’re a victim and how they are ready to ride in and save the day… just as soon as they get your vote.
Until next time,

Briton Ryle