Congress got a message today from Wall Street -- over their morning coffee while perusing the Washington Post. JP Morgan Chairman and CEO Jamie Dimon wrote an op-ed urging the nation's political leaders to end the too big to fail problem by creating a new non-bank resolution authority. He's probably pleased to see that both the House and Senate regulatory proposals would provide the Federal Deposit Insurance Corporation with precisely that role. I am too. But while I agree with Dimon's general plea, I am not on board with everything he says.
Before getting into his piece, I think it's worth noting what's going on here. A major Wall Street bank head is writing an op-ed to urge greater regulation which would allow giant financial institutions like his to fail. And he didn't choose an industry-oriented publication like The Wall Street Journal, The Financial Times or The Economist. He's catering to the audience that really matters -- Washington -- by choosing the Post.
Here's Dimon's central point:
The goal should be a regulatory system that allows financial institutions to meet the needs of individual and institutional customers while ensuring that even the biggest bank can be allowed to fail in a way that does not put taxpayers or the broader economy at risk.
It's not so surprising that Dimon, in particular, wishes a resolution authority was in place last year. If there was, his firm would likely be better off right now. Most people would agree that his firm's chief competitor in the full-service U.S. banking sphere, Citigroup, would have been resolved. Instead, the bank received a gigantic bailout and continues to struggle. Other big competitors, like Merrill Lynch, might also have been eliminated. Meanwhile, his bank was one of the healthiest, so its acquisitions, like Bear Sterns and Washington Mutual, would have still taken place. JP Morgan might have acquired even more assets sold through a resolution authority.
But here's where he loses me.
As we have seen clearly over the last several years, financial institutions, including those not considered "too big," can pose serious risks for our markets because of their interconnectivity. A cap on the size of an institution will not prevent that risk. Properly structured resolution authority, however, can help halt the spread of one company's failure to another and to the broader economy.
Now, I don't think what he's saying is entirely wrong. Caps on size don't necessarily prevent risk, but I think that they could in certain situations. In conjunction with a non-bank resolution authority, firms should have to submit failure plans -- explanations of how each firm could be wound down without creating a debilitating market disturbance. But what if a firm is so large that any failure scenario it can imagine would still cause the financial world to collapse? Then I think you would have to break it up.
The size of a firm's market presence matters when it comes to interconnectivity. Think about the human body. It's a very interconnected system. Your lungs and heart are vital organs. If your heart fails (and you can't get a transplant), then you die. It is, indeed, too big to fail. But if one of your lungs collapses, you might still be able to live.
In a similar way, if there are only a few very large financial firms that have a huge presence in an interconnected market, then obviously one of those firms' failures poses a greater systemic risk than if that market presence were spread over a few dozen firms. Whether one gigantic firm needs to be broken up, however, depends on the businesses it's in and what would happen to the financial industry if it failed. That's why I agree with Dimon that arbitrary caps aren't sensible, but I disagree with him that there aren't situations where firms might have to be broken up to ensure that resolution is possible.
Here's another related assertion Dimon makes, which I disagree with:
Capping the size of American banks won't eliminate the needs of big businesses; it will force them to turn to foreign banks that won't face the same restrictions.
That's a little silly. Unless the caps were extremely low, I find it unlikely that the U.S. wouldn't still have banks big enough to competently service the needs of big businesses. Moreover, the rest of the world is likely to cap or break up firms even more aggressively that then U.S. Just ask Great Britain.