In a recent FT article, PIMCO responded to Neel Kashkari's statement that the largest banks may need to be broken up, by stating that they think it is a bad idea. They make the following five assertions:
1. REGULATIONS ARE ALREADY HELPING. Better Banking Law does not disagree; however PIMCO goes on to state that several large banks have shrunk their balance sheets in recent years. But they neglect to say that, while one or two banks may well have done so, the fact remains that the four largest banks, as reported recently in the Wall Street Journal, in 2015 held $8.01 Trillion in total assets, which comprised 51% of all bank assets. Whereas in 2006, those same four banks held $5.18 Trillion of total assets, representing a mere 44% of the total. Some shrinkage!
2. A BREAK UP COULD PROMPT ANOTHER CREDIT CRUNCH. This is surely an odd argument, since it was the large universal banks that contributed in a major way to the financial crisis in '08 through their foolish underwriting of bonds backed by toxic mortgage assets and derivative securities thereof.
3. SMALLER BANKS ARE NOT NECESSARILY LESS RISKY. Better Banking Law has never asserted that small banks are not without risk. But when small banks have failed, the FDIC has very effectively dealt with those failures. However, when gigantic banks fail, FDIC funds become woefully inadequate and require, as in 2008, the bailout of such universal banks, to protect the nations economy. Furthermore, the smaller banks seldom deal in derivatives or other exotic financial instruments, which can lead and have lead to disaster.
4. BOND HOLDERS WOULD BE WARY OF NEW ENTITIES. At present, holders of the bonds of large US bank holding companies are unsure, due to BHCs complexity, just what the source of payment for their bonds may be. However, since all BHC bond holders were bailed out in 2008, such holders likely assume that the bank debt owed them will ultimately be paid by Uncle Sam. This moral hazard must surely end. BHC bond holders get significantly more yield than they earn on US treasuries, so why should such holders be bailed out again by the government?
5. THERE COULD BE A POTENTIAL INCREASE IN COUNTERPARTY RISK. After a breakup, a counterparty would be much more assured that a specific entity, which can be far better analyzed than the entire BHC, is responsible for its payment of its obligation.
PIMCO's final statement is as follows: "While further measures to encourage simpler and smaller balance sheets and operations may be needed, policymakers need to keep a close eye on their unintended consequences, no matter how politically appealing the measures may seem." Had this sentence not included the word "politically", it would have been fine. Sadly, with that word, the statement becomes a cheap shot. This issue is not political: it has to do with protecting taxpayers from a situation where, if things work out for the banks, their bondholders, stockholders and executives get the benefit. Whereas, if they fail, taxpayers are on the hook - as happened in 2008. Furthermore, to the extent politics is involved, the lobbyists and lawyers for the banks have far more access to Congress through their and the banks' own gigantic campaign contributions. Thus, the taxpayers become the only party without political representation in Congress.
Neel Kaskari's full speech "Lessons from the Crisis: Ending Too Big to Fail" can be viewed here.