Small Bank Big Trouble?

One of the more interesting counter-arguments against the idea that big banks should be broken up comes from people who play close attention to the behavior of small banks.  They point out that small banks are a powerful political lobby, a point nicely illustrated by the NYT’s explanation of how changes to bankruptcy law were recently derailed.

The big banks, in this view, are no more oligarchic in their tendencies than small banks.

It is definitely the case that small banks can get together and demand political favors.  You need transparency and a strong open debate to offset that – and, according to leading congressional figures, you also need the Obama administration to show up, help out, and resist capture:

“Moreover, Timothy F. Geithner, the Treasury secretary, did not seem to share Mr. Obama’s enthusiasm for the bankruptcy change.

Mr. Geithner was lobbied by the industry early. Two days after he was sworn in, he invited Mr. Fine from the community bankers to his office for a private meeting. The association, with influential members in every Congressional district, is one of Washington’s most powerful trade groups.”

The more interesting question is whether many small banks could copy each other’s behavior and create a situation where they are all “too big to fail” at more or less the same moment.  Some call this lemming behavior, but that may be unfair on the little critters.

Surely this is very hard to pull off in practice.  In his Logic of Collective Action, published in 1965, Mancur Olson argued that it’s hard for large groups to cooperate effectively, particularly when there’s an incentive to “free ride”.

What would free riding mean in this context, which is somewhat different from the public goods provision issue that Olson focused on?  Probably it would mean pretending that you’re just like the rest of the pack, but quietly hanging back as the pack heads towards the next subprime-type cliff – and then buying up everything you want from the wreckage.

Then you get to run ads like JP Morgan currently has over at the Atlantic – in a nice, but surely coincidental irony, this currently shows above the top of The Quiet Coup.  And, less likely to coincidental, the JP Morgan campaign has almost the same name as the main “constrain the big banks” movement: A New Way Forward.  (Presumably, Jamie Dimon, head of JP Morgan, couldn’t persuade McDonalds to part with the relevant rights to I’m Lovin’ It.)

The failure of big banks endangers financial systems and their rescue – as organized by the Bush and Obama administrations – results in a massive increase in the public debt.  The failure of small banks is an issue in some countries, but in the U.S., the FDIC takes them over for breakfast – here’s how they spent Friday.

Lemmings of the world, watch out for Jamie Dimon.

Originally published at The Baseline Scenario and reproduced here with the author’s permission.