Wednesday, December 4, 2013

FLG Hasn't Been Reading Blogs A Lot Lately

But Matt Yglesias is still a know-it-all who just so happens to not know very much.

He says the US has too many banks.  How does he define too many?  Doesn't really say.  In fact, the number of banks has fallen to 6,891 today from 14,482 in 1984.

But he makes three points:

  1. They are poorly managed
  2. They can't be regulated
  3. They can't compete

He makes his first point by arguing, basically, that if the people with degrees from HBS and Wharton can't run the Wall Street banks, then the people at these little banks must be even worse.  He then says that since these small banks are funded by FDIC deposits this creates a problem because nobody has an incentive to pay attention to what's going on.  The glaring omission here is that smaller banks are simpler operations.  They take deposits and make loans.  They operate very much as if Glass-Steagall had never been repealed.

His second point is basically the high overhead costs associated with regulation is a real problem for small banks and politically we are sensitive to that.  Matt argues this is because we are perversely committed to these small banks.  FLG thinks this illustrates one of his big issues with regulation generally -- it acts as a barrier to entry and benefits large, incumbent firms whose own bureaucrats can speak the government bureaucratic language.  The effect of regulation, especially after regulatory capture, is to protect the status quo power dynamics of the players in the industry.

The last point, that they can't compete, FLG is somewhat sympathetic to.   There are economies of scale to banking, but he's seen differing views on how much matters in research literature.  There is certainly a lower cost of funds in the market for the too-big-too-fail banks, which has been empirical verified.  But since these smaller banks are getting most of their funds from deposits and they stay within that limit, he's not sure it matters.

The only way FLG can make any sense of what Matt is arguing is if he began a thought experiment of the ideal bank size to comply with all sorts of regulations Matt might come up with.    The sweet spot for that would be just big enough not to be too big too fail, which is pretty pretty much the "US Bankcorps and PNCs and Fifth Thirds and BancWests of America" he likes.

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