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Regulators Debate Pros, Cons Of 'Too Big To Fail'
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Regulators Debate Pros, Cons Of 'Too Big To Fail'

Business

STEVE INSKEEP, host:

One thing that's not in the bill is a limitation on the size of financial institutions. Policymakers are trying to balance two concerns here. As we learned in the past year, really big financial firms can pose really big risks to the whole economy. At the same time, their supporters argue that big firms do things that smaller firms just can't.

NPR's John Ydstie has more.

JOHN YDSTIE: Among the most prominent advocates of some limitation on the size of banks is former Federal Reserve Chairman Alan Greenspan. If they're too big to fail, they're too big, Greenspan said recently. Mervyn King, head of the Bank of England, expressed similar sentiments in a speech last week. But speaking at a conference on Cape Cod this past Friday, the current Fed chairman, Ben Bernanke, disagreed.

Mr. BEN BERNANKE (Federal Reserve Chairman): We can address these issues in a way that doesn't destroy the economic value of large, complex multifunction firms through other mechanisms.

YDSTIE: So what is the economic value of huge firms like Citigroup or Bank of America? Professor Charles Calomiris of Columbia University gives this answer.

Professor CHARLES CALOMIRIS (Columbia University): Global banks are financial service providers to global firms.

YDSTIE: Like big automakers - GM, Toyota, Mercedes - they make cars in many countries and sell cars in even more. They need to raise capital around the world and have to manage exchange rate risks since they sell cars in many currencies.

Prof. CALOMIRIS: They have complex financial needs having to do with hedging. We're not going to be able to serve the needs of large global firms with mom-and-pop banks.

YDSTIE: Calomiris acknowledges that the failure of very large firms poses a potential danger to economies and taxpayers. But he thinks that with better regulation, including higher capital requirements, the danger can be managed, and he generally agrees with the Obama administration's approach. Calomiris thinks it's particularly important to put in place a better system for assessing the level of risk that financial firms are taking.

But former International Monetary Fund chief economist Simon Johnson, who's now a professor at MIT, says relying on tougher regulation won't work.

Professor SIMON JOHNSON (MIT; Former Chief Economist, International Monetary Fund): The basic problem is that the financial sector can hire the best, most talented people. It can pay them extraordinary amounts of money. They will always get ahead of the regulators.

YDSTIE: Johnson agrees capital requirements must be raised, and he says the revolving door between Wall Street and its Washington regulators must be bolted shut.

But he says at the top of the list should be limiting the size of financial firms to no more than $100 billion in assets. That's about 1/10th the size of the largest global bank now. He says that's certainly large enough to serve the needs of global businesses. Johnson says most of the companies he knows already work with multiple banks because different banks are good at different things.

Prof. JOHNSON: Particularly if you're working across so many markets, you really want people with excellent local knowledge. So you can work with a network of financial institutions and you can hedge any kind of position you have through multiple contracts with smaller players. In fact, it's probably not wise in this day and age to rely on one provider of financial services. You're less likely to get a good price that way.

YDSTIE: Calomiris says he disagrees. He says because of their economies of scale, bigger firms can charge less for their services. And he argues there's another benefit of big global banks: They've given small firms in emerging markets more access to capital. In Mexico, he says, six families used to dominate industry and banking and wouldn't lend to competitors. Then he says, in the 1990s, their banks crumbled during the Mexican financial crisis.

Prof. CALOMIRIS: And so we got a huge entry of foreign-owned branches in Mexico, which has completely changed the political economy of the banking system. It now operates at an arms-length efficient banking system, not a network for crony capitalism.

YDSTIE: Simon Johnson says that's just exchanging one set of powerful players for another.

Prof. JOHNSON: And the view that our banks are only good and forces for all kinds of progressive change is, I have to say, a little New York-biased. Most of the people in the rest of the world don't see it that way, and with good reason.

YDSTIE: Finally, Johnson says, any benefits of very large banks have to be measured against the potential cost of their failure, which the current crisis has demonstrated is immense.

John Ydstie, NPR News, Washington.

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