It's time to cut huge lenders down to size

At the broad level, there was much to applaud in the announcement from the White House regarding potential new constraints on the scale and scope of our largest banks.

After more than a year of tough argument, Paul Volcker has finally persuaded top aides to President Barack Obama that the unconditional bailouts of 2008-2009 planted the seeds for another major economic crisis. Unfortunately, in their scramble to announce this major policy shift ahead of Wall Street's bonus season, the administration didn't line up all relevant details.

In particular, the White House background briefing gave listeners the strong impression that these new proposals would freeze the size of our largest banks "as is". This makes no sense. Why would anyone regard 20 years of reckless expansion, a massive global crisis, and the most-generous bailout in recorded history as the recipe for creating right-sized banks?

There is no evidence, for example, that the increase in bank size since the mid-1990s has brought anything other than huge social costs in terms of direct financial rescues, the fiscal stimulus needed to prevent another Great Depression, and millions of lost jobs.

The administration has most evidently not done a great deal of other preparatory work. How will off-balance-sheet activities be treated? Should some hedge funds also be regarded as too big to fail? And why would merely controlling proprietary trading be enough to de-risk out-of-control behemoths, such as Citigroup?

Still, we should treat the next few weeks as the public- comment phase for potentially serious principles and an opportunity to press for workable details. The big banks, naturally, are already hard at work pushing in the other direction. This is actually good and exactly what we need. The banks have hidden behind their lobbyists and disinformation managers for too long. The administration has decided to take the fight to them, face-to-face, with the full backing of a president at last willing to press for change.

There are sensible people on both sides of the political aisle on this issue. But there is also Senator Richard Shelby of Alabama, who has been arguing that the morass of massive financial institutions can be handled through minor modifications of our bankruptcy code.

This is as nonsensical, and as unconnected to reality, as the view that the US can just become more like Canada, in the mythical sense of having four big banks that are well regulated. Please, just spend some time with people who know the facts and review in detail the breakdown of risk management at Canada's greatest financial institutions.

President Obama finally has economic logic and solid history on his side. If he comes out clear and strong on this issue he will flush out into the open the self-serving greed and frank stupidity that underpins the idea that bigger finance is good, unregulated big finance is better, and today's mammoth unfettered global banks are best.

As we drill down into the details of ideas for breaking the economic and political power of oversized banks, we need this litmus test against which serious suggestions should be judged: Does a proposal imply that Goldman Sachs should break itself up into at least four or five independent pieces, with the biggest being no more than 1 percent of gross domestic product, or roughly $150 billion?

If the answer is yes, we are making progress in moving our financial system back toward where it was in the early 1990s, when it worked fine (and Goldman was a world-class investment bank) and was much less threatening to the global economy. If the answer is no, we are merely repainting the deckchairs on the Titanic.

Simon Johnson, a professor at MIT's Sloan School of Management and former chief economist of the IMF. The opinions expressed are his own.

(China Daily 01/23/2010 page10)