Dean Baker says an accountable banking system must be composed of smaller banks

The health of any market depends on market discipline. Which substance is totally absent when huge implicit subsidies exist, such as too-big-to-fail insurance. We -- and Dean Baker here -- hope that we return to the Glass-Steagall system which worked rather than creating a new massive bureaucracy subject to the same flaws and fallacies of the current system.

Break up America's banks
Dean Baker
The Guardian, UK
September 21, 2009

The populist anger about Obama's bank bailouts transcends politics. We need a banking system accountable to the public

The large number of people who protested against Barack Obama's healthcare plan in Washington last week drew an enormous amount of media attention. Clearly some of the leaders are certifiably crazy, questioning whether Obama is an American and likening him to Hitler. But many of the protesters had reasonable concerns about how the plan would affect the quality of care that they and their loved ones receive.

It was also striking how often the protesters complained about a government that was out of control and not responsive to ordinary people. One of the items that often came up in the interviews reported in the media was the bank bailout. Clearly this is an enduring and deeply felt cause of resentment.

It would be very hard to tell these people that their concerns on this topic are misplaced. At a time when tens of millions of people are facing unemployment or underemployment, when millions are at immediate risk of losing their homes, the banks seem to be doing better than ever. Goldman Sachs used its government-guaranteed loans to make risky bets that paid off big time. It now plans to distribute $9bn in bonuses to its executives and top traders at the end of the year. Why shouldn't the protesters be absolutely furious about an administration that used taxpayer dollars to make some of the richest people in the country even richer?

It would be great if the anger of these protesters could be turned in a productive direction. Instead of trying to prevent the government from extending healthcare coverage, how about going after the banks that pillaged the country?

The obvious place to start in this effort is the break-up of the "too big to fail" behemoths. It is now pretty much official policy that financial giants like Citigroup, Bank of America and Goldman Sachs will not be allowed to fail. If their bad investment decisions again bring them to the edge of bankruptcy, the federal government will again rush to the rescue, handing out whatever cash and loans are needed to keep the banks afloat.

This status gives these banks a clear edge in credit markets against their smaller competitors. If everyone knows that the government can be counted on to come to the rescue of these banks, then there is less risk in lending them money. Therefore, they pay lower interest rates than if they had to borrow in a free market.

The Obama administration has proposed to correct this inequity by having higher capital requirements and tighter restrictions on risk-taking that will make it undesirable for banks to be too big to fail. In principle, the government could impose restrictions that are sufficiently onerous to offset the advantages of the government safety net, but no one outside of the Obama administration believes this will happen.

The simpler course is to just break them up. We don't have to turn Citigroup and Bank of America into hundreds of small community banks, just large regional banks that can be safely put through a bankruptcy/resolution process if they mismanage their assets. My guess is that most of people protesting healthcare reform last weekend would support this idea.

A second issue likely to draw the support of the protesters is the democratisation of the Federal Reserve. There is already a left-right coalition in the House of Representatives behind a bill calling for an audit of the Fed.

This is a case where the centrist elites have shown complete contempt for the American public. In fact, Federal Reserve Board chairman Ben Bernanke had the gall to argue against an audit of the Fed, warning that it would lead to increased instability.

Did Bernanke forget that less than a year ago he told Congress that the policies pursued by him and his predecessor had brought the economy to the brink of a complete collapse? How do you get less stable than that? This is the sort of nonsense that shows the contempt that the elites have for the masses on both the left and right.

This suggests a great opportunity for a joint effort by the left and right to democratise the Fed. It is absurd that the US has a central bank that is more accountable to the financial industry than to the public.

A joint effort has enormous potential. It will be hard for the elites to even understand such a joint effort of the left and right against the centre. As an example, the New York Times actually asserted that the bill to audit the Fed has "250 Republican" co-sponsors in the House, ignoring the fact that the Republicans are a minority in the 435 seat chamber.

But the ignorance of the elite only increases the probability of success. And, if there is one thing this economic crisis demonstrates, the elite can be very very ignorant.