The most commonly misunderstood narratives emerging from last year’s financial upheaval are that the crisis was caused by big banks, and that the crisis started with the failure of one big bank in particular – Lehman Brothers.
Neither narrative is accurate. Big banks had a role in the crisis, but they didn’t cause it. And Lehman Brothers – however cataclysmic an event it was – didn’t itself launch the crisis.
Misreading these story lines is leading some to argue for the need to break up or “skinny down” large U.S. financial institutions in the hopes of preventing a “too big to fail” problem in the future. Moral of the story: Big Banks are Bad.
But I cannot lie – I like big banks.
I like small banks, too. I like regional banks. I like community banks. I like savings and loans and thrifts. I like commercial banks and investment banks. I like the fact that in the United States we have a deep, diverse, robust banking system that serves the needs of businesses, consumers and investors of every shape and size – and that includes big banks.
Lehman Brothers became the poster child for “too big to fail” and the skinny bank fad. There’s no question that the failure of Lehman Brothers a year ago contributed to a near-catastrophe in financial markets and the global economy. Actual catastrophe was only averted by the government-led financial rescue in the form of the TARP program and extraordinary actions by the Federal Reserve.
But Lehman didn’t cause the financial crisis. Lehman Brothers was simply one of the initial casualties of what was already an ongoing systemic event corroding the financial system, namely, the failure of one widely held class of assets: residential mortgage-backed securities. The failure of Lehman was like a gas line exploding in a house already on fire. In the end, it accelerated damage and made containment of the fire more expensive, but it wasn’t the cause.
Over the decades, large, complex financial institutions —big banks— have been unquestionably beneficial to the U.S. economy, and to the global economy. Big banks efficiently facilitate cross-border trade and investment on a global scale, resulting in benefits that have consistently accrued to consumers and improved standards of living for people in all markets.
Large U.S. financial institutions have also contributed to the development of deep, liquid capital markets here in the United States, ensuring unique access to global financing for U.S. firms. Scale and scope are needed to sustain global trade and finance, and big U.S. banks are leaders in delivering those services.
There are ways to increase the safety and soundness of big banks – to prevent the kind of explosion we saw with Lehman Brothers, but breaking up our big banks is the wrong way to go. Initiatives to raise capital levels, improve capital quality, decrease leverage and improve liquidity – across the entire global banking system – make sense.
Make our big banks safer, but don’t make them skinny.
Tony Fratto is a CNBC on-air contributor and most recently served as Deputy Assistant to the President and Deputy Press Secretary for the Bush Administration.