Beware of the Risks of Breaking Up Big Banks

The financial crisis is usually dated as beginning in the middle of 2007, but officials did not appear to be truly coordinating a response until the failure of Lehman Brothers sent shock waves through the global financial system a little more than a year later. And even then, it seemed like officials simply slashed interest rates at the same time rather than planning and pursuing a coordinated path. In fact, the failure of the U.K. government to support Barclay's attempt to purchase Lehman appears to have estranged the Anglo-American relationship.

The lack of coordination is particularly evident in dealing with the "too big to fail" doctrine, or what the British refer to as "too important to fail." In Europe, the policy response that has emerged over the last couple of weeks is that such financial institutions need to be downsized.

European and British regulators appear to be aiming to create a more competitive banking system with smaller players. The E.U. insisted on breakup of the Dutch-based ING, while the U.K. government is forcing the dismemberment of its three banks. Swiss officials seem sympathetic to the proposition that "too big to fail" means "too big."

Lord Acton is famous for his assessment that "power corrupts and absolute power corrupts absolutely." In some respects, European banks operated in a less light regulatory environment than U.S. banks (though on the whole, they seemed more leveraged), and since that did not work, the remaining option is to break up these large banks. The economies of scale that are achieved are more than offset by the inability to manage risk.

The U.S. attitude toward power is different from Europe's. The policy implication that is drawn from Lord Acton's maxim is that power needs to be checked and balanced. It needs to be transparent, but it does not need to be dissolved. To be sure, there are some vocal proponents of breaking up U.S. banks. Ironically some on the political right and left advocate precisely such a course. However, on balance, the Obama administration appears to be more inclined to tighten the regulatory regime considerably rather than breaking up the banks.

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Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback; click here to send him an email.