Break up the big banks -- now

By Zephyr Teachout, The Big Money

Last week, Democratic Sens. Sherrod Brown and Ted Kaufman introduced a bill that would break up the biggest financial institutions and cap bank size so that they can never get so big again. Senate Banking Committee Chairman Christopher Dodd hasn't yet bought it, the Obama administration hasn't bought it, and the biggest banks aren't keen on it.

Yet the Safe Banking Act of 2010 might be the single most important piece of financial reform legislation under consideration, and it's the only legislation on the table that could protect against what should be our two biggest worries:

1. Another major meltdown driven by financial institutions that aren't worried about failure.

2. An economy run by uncompetitive, enormous financial institutions that distort the market because they are too big to be bothered to compete.

Typically, when confronted with the prospect of breaking up big banks, bankers and their apologists argue that socially useful economies of scale are endangered. But it's worth asking: What are the economies of scale that come along with a bank that has, say, $2.2 trillion in assets? (That's Bank of America (BAC, news, msgs).) Given that our six largest banks are now collectively worth more than 60% of U.S. gross domestic product, it's a burning question.

• Today's mortgage rates

When it comes to socially useful services -- lending, deposits -- there is a lot of research and no evidence that the enormous banks provide better services or even the same services at lower costs. And if you plunge into the weedy debate about bank size found in the economics literature, you'll find that it is about whether economies of scale drop off at $200 million in assets, $500 million in assets or $50 billion in assets -- much smaller than the scale we're talking about.

The problem is that the banking industry has become so concentrated in the past decade that it no longer functions as a competitive market. This is not a view held exclusively on the left. As conservative economist Arnold Kling recently wrote in National Review: "Big banks are bad for free markets. Far from being engines of free enterprise, they are conducive to what might be called 'crony capitalism.'"

The big argument from the banks in the '90s was that if we didn't deregulate, U.S. banks would lose out to foreign banks. The banks won the argument, but the dismantling of regulation hasn't served us well so far. Moreover, we're not talking small banks, by any means -- the proposed cap still leaves U.S. banks bigger than banks from other countries.

More importantly, we are the world leaders in banking, and other countries are already moving toward size caps -- if we do a size cap, the countries that haven't yet will follow suit. Moreover, because there are no demonstrable consumer advantages to big banks, the banks that are too big will end up burdening other governments' treasuries when they are bailed out. In contrast, a reined-in American system would be more stable, and therefore more competitive, in both the short and long term.

But there is actually one place where bigness yields clear economies of scale: lobbying, particularly in the form of what economists call "rent-seeking." That is, companies "seek" to earn income by using political connections to manipulate laws instead of by making better products.

Continued: Betting into the moral hazard

More from MSN Money and The Big Money

• 5 lies the big banks keep telling us
• Does boycotting big banks make sense?
• Goldman-deal gamblers knew the score
• Slide show: A history of the credit card
• Goldman's take-no-prisoners attitude
• Why  investors won't revolt

 1 | 2 | next >