Understanding the 2008 Recession and the Question of Bank Breakup
Post the 2008 global recession, there were calls to break up the too-big-to-fail (TBTF) banks. The theory was that breaking up these institutions would mitigate systemic risks and ensure financial stability. However, the actual implementation faced a myriad of challenges rooted in political, legal, and economic considerations. This article delves into these complexities and explains why the big banks were not broken up as many hoped.
Political, Legal, and Economic Challenges
The decision not to break up big banks after the 2008 global recession can be attributed to several factors:
Adverse Selection in Asset Repackaging
One major challenge in breaking up banks is the adverse selection problem. Insiders of the bank may reorganize the assets, keeping the best assets for themselves and loading the riskier ones to outside investors. This behavior would only exacerbate the separation of risk and reward, making the process of divestiture difficult and contentious.
Basel II and III: Increasing Capital Requirements
The implementation of Basel II and Basel III aimed to increase capital requirements for banks. Though intended to reduce counterparty risk, these standards have led to higher costs of intermediation, particularly in over-the-counter (OTC) markets. This has reduced competition and has enabled banks like Goldman Sachs (GS) and Morgan Stanley (MS) to dominate many markets, further limiting the potential for breakup.
Potential Concerns of Bank Breakup
If the notion of breaking up the big banks was given serious consideration, several significant issues would arise:
Complex Regulatory Rules
The first major concern is the creation and enforcement of regulatory rules. Business segments, banking versus investing versus trading, could be the lines along which the banks are broken up. However, ensuring that these rules are fair and equitable is challenging. In the face of combined legal resources of the banks, it remains uncertain whether the government could effectively challenge them in court.
Legal Implications
Even if the courts ruled in favor of breaking up the banks on certain issues, partial application of these rules could pose problems. A successful breakup might hinge on the thoroughness and consistency of the new regulatory framework.
Management and Oversight
The management and oversight of such a process are critical. If an agency were to oversee the breakup, it would need to be bipartisan and politically insulated to avoid becoming a political football. This would require careful planning to ensure that the task is not politicized and that the process is handled with seriousness and transparency.
Financial and Practical Challenges
Breaking up such large and complex entities presents numerous financial and logistical challenges. Similar to the breakup of famous wealthy individuals, the assets, liabilities, and trading activities of these banks are intricately woven and may be difficult to separate. Revealing all these details to regulatory bodies is not without its own risks, as it could affect the overall health and stability of the financial system.
Impact on Financial Power and Global Dominance
Another concern is the potential impact on the financial power of major US banks and their global dominance in substantial financial activities, such as mergers and acquisitions (MA).
End Goals and Motives
The motives behind breaking up the big banks are also open to scrutiny. Is the ultimate goal simply to mitigate risk, or is it a form of punishment? Could it be an attempt to satisfy the demands of various stakeholders? The answers to these questions are not clear and may depend on the specific context and motivations of the decision-makers.
Conclusion
While the concept of breaking up big banks seems straightforward in theory, the practical implementation is fraught with challenges. The issues of adverse selection, increasing capital requirements, and legal and regulatory complexities make the process difficult. Moreover, the potential impact on financial stability and power dynamics requires careful consideration.
Ultimately, the decision not to break up these institutions after the 2008 global recession may have been a rational choice given the complexities involved, much like certain historical decisions that were easy to conceive but difficult to achieve.