Beltway Confidential

Megabanks are a creature of government, not of unbridled capitalism

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Beltway Confidential,Timothy P. Carney,Finance and Banking,Big Government,Analysis

How could a free-marketeer want to break up the big banks? In part, because the megabanks are not the creatures of capitalism, but of government.

Jim Pethokoukis at National Affairs has a great contribution to the libertarian populist oeuvre (can a populist use a French word?), on this subject. Writing on how FDIC insurance evolved from protecting depositors to protecting banks, Pethokoukis writes that the banks:

did not take long for banks to adjust their behavior accordingly. They realized that the bigger and more interconnected they became, the more essential they would seem in the eyes of regulators, and thus the more insulated from failure they would become. This increased security, in turn, afforded the big banks a huge market advantage over their smaller competitors, allowing them to bloat even more — thereby perpetuating a dangerous cycle of uncontrolled growth ...

Banks are not growing this large and unwieldy purely because of competition and the global market. Decades of experience have proved that when a firm rises to the status of “systemically important” (as Dodd-Frank labels such large, interconnected banks), it will pursue increasingly risky ventures. If those ventures succeed, bankers and shareholders make money; if they fail, American taxpayers foot the bill. The federal government has thus established, and continues to subsidize, an enormously profitable business model for certain megabanks. It’s no wonder that the nation’s financial institutions are actively seeking to become “too big to fail”: Once they do, they can’t lose….

Wall Street’s basic job — the allocation of capital — is fundamental to our free-market economy. But a system in which select firms are protected by the government against the possibility of failure is not a free market: It is little more than a rent-seeking racket. The danger of loss is what motivates markets to impose discipline on borrowers and to take only smart investment risks. Because of the government’s long legacy of interventions and bailouts, that discipline is now far weaker than it should be.

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