Saturday, August 29, 2009

Concentration in US Banking

According to The Washington Post (Friday, August 28) since federal regulators pumped tens of billions of dollars into the leading financial institutions because the banks were so big that officials feared their failure would ruin the entire financial system, the biggest of those banks have grown even bigger.

J.P.Morgan Chase now holds more than 10 percent of the country’s deposits, as does Bank of America (partly government-owned as a result of the crisis) and Wells Fargo.

Those three banks, plus government-rescued and –owned Citigroup, now issue one of every two mortgages and about two of every three credit cards.
As a result, depositors are seeing fewer choices and higher prices for financial services. “The oligopoly has tightened” comments Mark Zandi, chief economist of Moody’s Economy.com, even though the concentration ratios are much higher in other countries’ banking sectors added Treasury Secretary Timothy F. Geithner in an interview.

Another unhappy consequence is that “moral hazard”, the accrued incentive for these larger banks to return to the risky behavior that led to the crisis if they figure federal officials will rescue them again, is increased too.

The question now is: will this regulatory-induced concentration lead to a reduction of the sector’s excess capacity, one of the main causes of the crisis? (more on that on a future post). Since letting the capacity reduction operate through bank failure was obviously too dangerous, the chosen alternative way to do it is by merging big firms first, and then let the managers reduce the capacity of the merged institutions, thus avoiding to jeopardize their survival.

But managers do not like to do that as Michael Jensen (emeritus Harvard Business School) often emphasized: internal control systems often fail. It is to be seen if some pressure from the legal-political-regulatory system will succeed in reining in banking excess capacity.

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