Everybody talks about the "Too Big to Fail" problem: financial institutions that are so huge and interconnected that, when they run into a crisis, the public will always bail them out, because the consequences of not doing so would be catastrophic for everyone. Nobody does anything about it. Maybe that's because banks have powerful lobbyists; maybe it's a human psychological flaw that causes us to stop worrying about inevitable future crises as soon as the last crisis seems to have passed.

No matter the cause, the solution is simple. It's time to break up the banks.

Normally, capitalism has a built in system that regulates risk-taking: failure. A business can take as many financial risks as it wants; if they don't work out, the business can fail. This generally causes businesses to avoid drastic, reckless financial gambles, in the same way that you generally avoid putting your entire life savings on the roulette wheel in Vegas, just because you might win a lot of money: the downside is that you lose everything.

But banks are different. The biggest banks have grown so large and interconnected that they can reasonably expect to be bailed out, should they risk insolvency. This is exactly what happened during the 2008 financial crisis. Rather than let financial institutions eat the consequences of their own bad bets and go out of business, we bailed them out and saved them. Since bankers are (in some ways) both smart and rational, they understand that they are able to take financial gambles that businesses in other industries would never dream of doing. Why? Because if they win, they keep their winnings, and if they lose, the public helps cover their losses. This causes banks to engage in risky practices, which inevitably leads to financial crises. The public's bailouts of the financial industry amount to a huge tax levied on all of us to allow bankers to pursue riskier paths to profit.

It's no wonder, of course, that we bail out banks. The current alternative is doom for us all. The latest attempt to calculate the real value of big banks finds that just four institutions—JPMorgan, Citigroup, Bank of America, and Wells Fargo—have combined assets nearly as large as the entire U.S. economy. It's not as if allowing them to fail would just punish the bankers who took those inappropriate and reckless risks in the first place. Those people are already rich. Allowing these massive institutions to fail would vaporize the assets of millions upon millions of Americans and destabilize our entire financial system, leading to who knows what level of chaos. The literal disintegration of civilized society (at least temporarily) would not be out of the question.

Even an idiot child or blogger can see the primary problem here: these banks are too big. If your local community bank got taken over by a greed-crazed gambler, made tons of risky bets, and lost, and went out of business, well, no biggie. You can go to the bank across town, that's not so poorly managed. But if JPMorgan exhibits the exact same behavior, well, shit, we can't let them go out of business, because then the other huge financial institutions that trade with them would go out of business, and the entire American economy would revert to 1492 status. The financial industry is too consolidated, and the banks are too big. There is no flexibility in the network. The major players have become so powerful that they are able to, in essence, force governments to clean up their messes, in a massive game of economic Chicken.

This is not a new idea. In The Black Swan, a book about the consequences of rare, unpredictable, extreme events published in 2007, before the great financial crisis struck, Nassim Nicholas Taleb wrote:

[Globalization]... is not all for the good; it creates interlocking fragility, while reducing volatility and giving the appearance of stability. In other words it creates devastating Black Swans. We have never lived before under the threat of a global collapse. Financial institutions have been merging into a smaller number of very large banks. Almost all banks are not interrelated. So the financial ecology is swelling into gigantic, incestuous, bureaucratic banks (often Gaussianized in their risk measurement)— when one falls, they all fall. The increased concentration among banks seems to have the effect of making financial crisis less likely, but when they happen they are more global in scale and hit us very hard. We have moved from a diversified ecology of small banks, with varied lending policies, to a more homogenous framework of firms that all resemble one another. True, we now have fewer failures, but when they occur... I shiver at the thought. I will rephrase here: we will have fewer but more severe crises.

The year after this was published, the global financial system blew up in exactly the way Taleb predicted. Today, we are still suffering from the effects of that crisis, but the structure of the banking industry has not been significantly changed. U.S. banks made a profit of $37.6 billion in the third quarter of 2012. They have absolutely no incentive to change, even though the risk of structural collapse remains the same as it was in 2007.

The tendency of a few massive companies to monopolize industries is good for the companies, but bad for you, the consumer. That's why we have anti-trust laws. Even standard mega-corporate growth has significant drawbacks—but at least in some industries, it has upsides as well. We can argue over whether or not the growth of Wal-Mart is a net good, but at least its size pushes down prices for consumers. Not so in the banking industry. The growth of these huge mega-banks, and the growth of their non-retail banking businesses which bear no resemblance to what normal banks do (take in deposits and make loans) does not benefit you, the consumer. It benefits the financial institutions. It allows them to keep in-house control of the entire spectrum of financial activities. It allows them to reap greater profits for themselves. And it raises the risk of another massive financial crisis, which will have devastating effects on average people and on the public treasury. Too Big To Fail-sized banks are, in the long run, not good for anyone except bankers.

How to fix the problem? That's not complicated either: make banks responsible for their own losses, and subject to normal competitive forces like other businesses. Since at a certain level bank losses can greatly damage society at large, that means limiting the size of banks. In capitalism, profit comes from risk, and risk entails a certain amount of failure. The problem is not that banks sometimes fail; it's that banks have gotten so big that if they fail, we all lose. Taleb wrote that "We would be far better off if there were a different ecology, in which financial institutions went bust on occasion and were rapidly replaced by new ones, thus mirroring the diversity of Internet businesses and the resilience of the Internet economy."

Banks that know they will bear their own losses will naturally behave more responsibly. They will be more prudent with loans; they will be far less likely to take fliers on exotic derivatives that risk blowups that could sink the entire firm. They, not the public, will be expected to bear the risk. And if they don't manage that risk well, they can fail. The financial system itself will be okay.

A financial system composed of a tiny group of Too Big to Fail banks represents the massive and unchecked consolidation of corporate power that liberals despise. It also represents the uncompetitive, anticapitalist, fiscally imprudent type of elitist cronyism that conservatives despise. Breaking up the banks is an issue that everyone—except bankers—can agree on.

So do it, already. Don't wait until the next crisis to have this conversation all over again.

[Image by Jim Cooke]