Only Breaking up Big Banks Protects from the Next Bank Bailout

Published on Current Concerns, by Joseph Stieglitz in an interview with Swiss radio DRS, Issue No 19, november 2010.

… Beat Soltermann (radio DRS): … And what about the regulation of those financial institutes that are too big to be sent in bankruptcy?

Joseph Stiglitz: One big area where they did not grapple with what has to be done, are the too-big-to-fail banks. That topic is very difficult, because the too-big-to-fail banks are also too powerful to regulate. And so well, most economists have the opinion that something must be done, almost nothing has been done yet.

The issue of the too big banks in Switzerland is of course a hotly debated topic. With CS and UBS we have two big banks in a relatively small country, and a commission of experts of the Federal Council is looking for a solution to this whole thing by the end of this month. What would be your solution

The evidence that these very big banks are more efficient, that they are, in the economist jargon, economies of scale or scope – there is very little evidence of that, but there is clear evidence that the too-big-to-fail banks have the advantage to get money at much too favorable conditions, as they must be saved in an case of emergency. That is unfair. And that they are too big to be managed correctly. So, my own view is that given this very little evidence, I would say that we need to break them up … //

And how do you want to do that?

There are two ways of breaking them up. One way is focussing. But most US banks are active in a great many areas at the same time. Commercial lending, the whole variety of investment banks, commercial banks, pick what you want to do, and take those other activities and put it in another institution. So by having focused on the management of the banks the risks are reduced. And there is one approach that has been discussed in the United States – to rebalance the distortions is to impose a higher tax. But that is not a good solution, for me that does not go far enough, because the bank bosses would not change their behavior because of the tax. They want to head big banks. So the shareholders would lose a little bit of money. Not a big deal. So imposing the tax may disadvantage the bundle of the shareholders but the decision-makers are the bank officers, to a very large extent. So it will help bringing it into balance but it will not necessarily really solve the issue.

And for Switzerland? What would you do with the two big banks, if you were e.g. king of Switzerland?

I think I would do exactly what I said the United Stated should do, have them focus on only one business area. And if the banks are still too large then, continue to break them up. Swiss banks have a wonderful reputation for good banking. They have done a good job in banking and so it would be a real shame if the strong reputation of that large part in the banking sector that is well-behaved is tarnished by these almost inevitable problems that arise when we have these too-big-to-fail banks.

Joseph Stiglitz, if I understand you correctly, then only very strict measures will protect us so that we will not have to save the next major bank with tax billions soon.

Let me make it clear: In the United States, for instance, we have the too-big-fail banks. For example in the USA the government says now: “Do not worry about the big banks. If they are threatened with bankruptcy, we will close them down.” And the government is talking about emergency plans and strict laws. But we all know what will happen. When a crisis happens and they’re about to fail, we will bail them out. And we will bail out not only the banks but also the bankers and the shareholders as well.

Therefore this is the important lesson taught by the financial crisis: If the major banks see only one possibility, namely that they must be saved by the state in an emergency in order to prevent something still worse, they will behave in an accordingly imprudent way. Bankers must be made to take more responsibility. And everything that you can do to move in that direction ought to be done. (full text).

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