Big is Ugly

Originally published September 3, 1984

THE Continental Illinois and the Financial Corporation of America bailouts, although different in nature, have one glaringly obvious lesson that everyone sees and even talks about endlessly yet refuses to think about. The lesson is that this bank and this thrift institution were too big to be allowed to fail, just as Chrysler and Lockheed were before them.

Everyone knows and says that. Everyone has enough mathematics to know as well that if Financial Corporation of America, the nation’s 12th-largest organization of its kind (counting both commercial banks and thrifts) is too big to be allowed to go under, there must be at the very least 11 others in the same category. Clearly, Citibank and Chase and the rest did what they did in South and Central America because they were confident that no matter what happened, they would not be allowed to fail, and in the meantime they could make a lot of very big loans at very high interest. Still, only a few people – like William Wolman, editor of Business Week – dare to say that in the end many, if not most, of these loans will be repudiated, and that Uncle Sam will, in one way or another, pick up the tab.

This may not be so bad in the event as it looms in contemplation. You have probably been struck by the fact that an awful lot of money is involved, and that no one seems to be certain exactly how much; yet whatever the amount, it is not overwhelming in relation to our national debt or even to our annual Reaganomic deficit. When Uncle Sam picks up the tab, we won’t be bankrupted. Indeed, we may be sure that the whole operation will be handled in such a discreetly indirect way that we will not notice it. There is a time for flamboyance and a time for discretion, and bankers are very good at telling which is which. Have you heard anything about the Polish loans lately?

More than money is at issue here. There has been talk about having someone – the Federal Reserve Board, the Comptroller of the Currency, the Federal Deposit Insurance Corporation, or some private insurance company – look more closely over the bankers’ shoulders. New laws are being proposed, and complaints are being made that old ones are not being enforced. The bankers are not much concerned, though, because they know that not much can come of it.

As long as the big banks are substantially free of regulation on the interest they can pay, they will be free of significant regulation elsewhere. Walter Wriston, the recently retired chairman of Citibank, who may be said to have initiated the current state of affairs with the dictum that countries don’t go bankrupt, now says that bankers are too proud to conduct their business in the expectation that the government will rescue them from their mistakes. He is undoubtedly as reliable one time as the other.

Early last month, the New York banks had a little war to see who could pay the highest interest on certificates of deposit. The war was apparently started by Manufacturers Hanover as a macho gesture, to show that current rumors of its weakness were false. An ad for Citibank, and several others, at one stage quoted an effective annual rate of 13.6 percent on one-year CDs. That sounded dandy (and was) for those with the cash to take advantage of it.

You may wonder how, with a prime rate that was then 13 per cent, Citibank could pay 13.6 per cent for its money. Mr. Micawber would have said: “Annual income thirteen per cent, annual expenditure thirteen and six-tenths, result misery.” It’s pretty hard to fault Mr. Micawber’s reasoning. Are bankers alchemists after all?

AT LEAST three things are going on behind the scenes. The first is that the bankers are practicing alchemy-up to a point. When they increase their reserves by selling you a CD for $1,000, they are able, very conservatively, to increase their lending by $5,000. A prime rate of 13 per cent on $5,000 earns them $650; so they can easily afford to pay you $136 for your money and are happy to spend a lot on television and newspaper ads to lure you into their shops.

(Incidentally, should similar battles flare up among the banks where you live, you might want to keep in mind that you can be an alchemist, too – assuming you are in the 50 per cent bracket and have some security to offer. It’s easy: You borrow $100,000 from Bank A, paying perhaps 15 per cent interest. You use this money to buy a $100,000 CD from Bank B that will earn $13,600. Since your tax will be reduced by $7,500 because of interest paid, you will have a profit of $6,100. After taxes you will be left with $3,050 net-all for simply signing your name a few times, and having a lot of money to begin with. And if you run part of this through your IRA, your gain will be greater.)

Can the banks continue doing that forever? Well, it isn’t quite like a chain letter, but it can be kept up as long as there are people and businesses clamoring to borrow money. (The private dodge I have outlined for you can be pursued as long as Congress allows a deduction for interest paid.) Should the demand for loans collapse, or should the loans turn “nonperforming,” the party would be over. For this reason, one may presume that a modest shuffling of the feet is also going on behind the scenes as the banks get ready to raise the prime rate again, probably not until after the election.

And why not? It’s as plain as day that their little CD wars will result in a higher cost of funds for all of them. Finally, a playlet is being prepared behind the scenes that will go like this:

Enter Stern Bank Examiner, who says (sternly): “Hey, you’ve got to stop making those crazy loans to Third World countries and oil wildcatters and speculators in California real estate. Even though the United States has figured out how to have what we say is a recovery with eight or 10 million unemployed, the rest of the world is still depressed, and the demand for oil is going down, and there really is a limit to what anyone in his right mind will pay for a piece of the San Andreas Fault.”

To that, Deregulated Big Banker will reply (contritely): “Well, shucks, sir. Then this bank, which I remind you is bigger than you can possibly imagine, will have to go bankrupt, because our cost of funds is so high that we have to make these crazy loans at high rates, or we can’t pay our bills. If you say we have to go bankrupt, why of course, we’ll do as you say. But if we go, I humbly remind you, we’re so big that we’ll pull a whole lot – maybe everything-down with us, and we wouldn’t like to do that. ”

Whereupon Stern Bank Examiner will answer (sternly): “Well, all right. If you can’t be good, be careful.”

The consequences of such unavoidably permissive regulation will extend far beyond the cost of bailing out a superbank every now and then. Most immediately, the rest of the banking system will be strangulated. If the biggest banks are essentially free of regulation, the remaining banks (some of them bigger than I can imagine) will be at a competitive disadvantage unless they can sell out to a super bank or combine with others similarly situated and become superbanks themselves. The merger movement, already possessed of enough momentum to satisfy a sports announcer (including one formerly known as Dutch[1]), will proceed apace. Everybody will become too big to be allowed to fail.

That last sentence is twice as long as it should be. If we are truly to learn the lesson of Continental Illinois and Financial Corporation of America and Lockheed and Chrysler, the sentence should read, “Everybody will be too big.” Period. Put another way, the lesson we should learn is that great size, in and of itself, is an economic evil. For almost a century, since the passage of the Sherman Antitrust Act in 1890, we have said and repeated and contrived to believe that the issue is competition, not size. The Sherman Act has been amended and strengthened, most notably by the Clayton Antitrust Act of 1914 and the Robinson-Patman Act of 1936; the courts have been clogged with cases, some of which dragged on for decades without a decision; and always the effort has been to discover and enforce a judicial definition of competition.

The effort has not succeeded. The power of the “trusts” of 1890 was insignificant in comparison with that of the Fortune 500 or the Forbes 500 of today. Absurdities have multiplied. It is, for example, established antitrust law that a company can engage in what the law defines as unfair business practices when the company has to do so to meet competition. If you think that’s nutty, you’re right.

I’m not saying that we would be better off without Robinson-Patman and the rest. I’m merely saying that the expensive, time-consuming antitrust effort has failed to come close to its promise, and that its failure follows from the apotheosis of competition.

In this space a couple of months ago (“Unthinkable Thoughts on Competition,” NL, April 2), I presented some empirical evidence that competition doesn’t always work for the benefit of the consumer. For evidence that it doesn’t always work for the benefit of the producer or of society, I refer you to a 1921 essay entitled “The Ethics of Competition” by the late Professor Frank H. Knight of the University of Chicago. Knight demonstrates in careful detail what we know in our hearts, namely that the competitive race is seldom fair, and that the effort it stimulates is as likely to result in chicanery as in beneficial innovation. One of Knight’s favorite pupils was Milton Friedman, showing that, happily for mankind, personal relations are thicker than ideology.

If competition doesn’t work, what does? Not cooperation. That is merely the flip side of the coin. Milovan Djilas and a great many others are ready to tell you in convincing detail that cooperative societies, with the best will in the world, tend to degenerate into stultifying dictatorships. I propose that we look a bit more closely at the question of size.

SINCE THERE ARE unquestionably economies of scale, it would seem that we are stymied in that direction, too. As a matter of practical politics, we are undoubtedly stymied now and will be for a long time. But there does exist a workable solution. It is embodied in a 166-page book published in 1947. The title is The Limitist, and the author is Fred I. Raymond.

Raymond was a successful executive in a family business that was sold, against his advice, to Wall Street speculators. Then he was an inventor of successful heart-regulating devices that he had to sell to Minneapolis-Honeywell because he couldn’t get at the market for them. Then he pondered what had happened to him and wrote his book, which I am very proud to have published. It attracted attention from John Chamberlain of the Wall Street Journal on the Right and Senator Paul Douglas of Illinois on the Left, but of course was (and unfortunately still is) long before its time.

Observing the courts’ inability to define competition, Raymond put forward what he called a limitist law. The speed limit is such a law. If you go over 55 miles an hour you are in violation, no matter what arguments you can make about safety or efficiency or the behavior of others. Observing the way business works, Raymond concluded that seeming economies of scale are often (if not generally) results of the favored access great size can command to finance and to markets. The Chevrolet plant in Tarrytown, New York, for instance, achieves (or could achieve) all the engineering economies of scale available in automobile manufacturing. It is not made more efficient by the existence of similar Chevrolet plants elsewhere.

On the basis of these observations, Raymond proposed that a business organization could be as large and as spread out as it wanted to be, provided that it had only one place of shipment to its customers, whether other manufacturers, retailers or the public. If a business had more than one point of delivery, it would be limited to a certain number of employees. Raymond suggested 1,000 as the maximum. He drafted a “Business Limitation Act” that runs to not quite 2,000 words, including definitions of terms.

I doubt that you have heard of a more elegant, simple, effective, and far-reaching proposal. The book never sold many copies and has long been out of print, but I suppose you can find one in some library. If you do, you will be well repaid for the two or three hours it takes you to read it. It is, as Chamberlain said, “a practical way of dealing with the economic ‘sin’ of bigness that doesn’t require cumbersome bureaucratic supervision, insidious taxation of human energy, or incessant effort to prevent government corruption.”

We can, of course, simply give up and turn the country over to the Business Roundtable. Or we can keep muddling through the courts. Or we can make a start at diagnosing and treating our actual ailment. That is, we can face up to the problem of bigness.

The sad fact is that we had a limitist law in banking in the shape of Regulation Q, which limited the interest certain banks could pay. It was not altogether effective because it could not (given the patchwork control of our financial system) cover all it should have covered. In the circumstances it would have been rational to extend the coverage. But overawed by the wealth and wisdom of Walter Wriston and his ilk, we reduced it, instead. The more fools we.

The New Leader

[1] Reagan

1 comment
  1. Diligent readers will find an error in the description of how tax laws enable rich people to make money in the post, “Big is Ugly.” As this link indicates,, whilst readers were sending in messages of alarm the author was already on the case. He’d forgotten the role of municipal bonds in the process.

    There also follows a letter about the original article and a commentary about the correction. They are found here:

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