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Sunday, December 05, 2010

Much of what investment bankers do is socially worthless

That's the headline on this blog post
based on this article by John Cassidy.
In a way, this is completely obvious on two levels:
(1) not all of what anybody does is socially beneficial, and
(2) didn't these guys just create the current deep world-wide recession? Or, if they didn't create it, they helped it along and collected big fees along the way.
But there's much more detail here, which is worth reading.
The question to me is: now that everybody knows this, what are we going to do about it? If many banks are now "too big to fail", why are we no figuring out how to make them smaller, so they are "small enough to fail"?
How to make them small enough to fail:
1. Let's separate backroom operations, first, to make it easier on people. Even right now, these are often different companies. For example, brokerage firms might use Pershing / Donaldson Lufkin and Jenrette as their backoffice.  Checks are cleared through the Federal Reserve.  Backoffice operations depend on reliability and efficiency. They are inherently not risky-taking entities and I don't think their size poses a particular risk.
2. Set up certain measures of size that may not be exceeded. For example, a bank may only have x% of total US deposits. There will be multiple measures of size and the bank has to stay inside all of them.
3. If the limits in #2 are exceeded (or really as the bank becomes close to them), the bank is likely to take some actions. They might sell off pieces, or split themselves in two and distribute the two pieces to shareholders. They might raise prices to drive off customers. Lots of things can be done.
This need not affect customers in any real way because of #1 -- the operations level would be pretty standardized.
This may actually be smoother than merger and acquisition activity in the past because it would become routinized.  Just speaking from my own experience, Chase has a poor idea of my account history under prior owners (Bank One, NBD, First Chicago, 1st Federal of Wilmette, Glenview Guarantee). They can't even tell me the basis of stocks I purchased through their brokerage some years ago.
Note that this means that there is still an incentive to grow, in order to have pieces that can be profitably spun off (like with any conglomerate, the aim is not so much to get bigger as to buy and sell profitably).
4. What about those megadeals that need big financing? I would note that these are syndicated now, and could be syndicated in the future -- just with more pieces needed.  One might also consider what social value has been created by these megadeals. If they disappeared, what would be the social loss?
5. This avoids moral hazard because the pieces would be small enough to fail. This might lead to substantial improvements in the overall system efficiency (rather than the inefficiency caused by privatizing profits and socializing losses).