$3 Billion Banks

By James Kwak
Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.
“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.
“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”
So what does Jon Macey think of big banks?
In a new Feature** in the Yale Law Journal, Macey, along with James P. Holdcroft, Jr., argues that banks should be broken up into pieces no bigger than $3 billion. According to Macey and Holdcroft, the basic problem is that the government cannot credibly commit not to bail out too-big-to-fail banks in a crisis. Or, more precisely, the only way it can commit not to bail out TBTF banks is to break those banks up before the crisis hits. Their proposed limit is 5 percent of the FDIC Deposit Insurance Fund, which itself is 1.15 percent of total insured deposits, so the limit would work out to $3 billion as of 2010. (Actually, that limit would apply to bank liabilities, so you could have a bank of any size you wanted, as long as the rest of its capital was equity.)
So, according to Macey and Holdcroft, the most notorious proposal of 13 Bankers – limiting banks to 4 percent or 2 percent of GDP (about $540 billion or $270 billion), depending on their function — was far too timid. While we would have broken up six banks, the Macey-Holdcroft proposal would break up over two hundred.
There is no inconsistency between this proposal and Macey’s general skepticism about regulation. What he is skeptical about is the government’s ability to precisely engineer desired market outcomes. Instead, what he prefers is a simple rule that makes possible free market competition without the distorting effect of implicit government subsidies: “Our proposed approach does not require any restrictions on activities of banks or on the location of those activities of any kind. Our only restriction is on the size of financial institutions.”
Of course, the chances that the government will break big banks into $3 billion pieces is no greater than the chances of those banks being broken into $270 billion pieces. What Macey and Holdcroft really demonstrate is the logical outcome of a free-market approach to the financial system. What is strange, by comparison, is the bizarre alliance of pseudo-technocratic centrists and anti-government conservatives supporting today’s behemoth banks.
* I have no idea why every law review article refers to itself as an Article. As I learned it, capitalization was only for the names of unique things, not for any old referent to a unique thing. Obviously “this Article” refers to a unique article, but so does “this cupcake” in the sentence, “Do you want to eat this cupcake?” and we don’t capitalize “cupcake.”
** Don’t ask.