Big Banks, Deleverage or Perish

Banks today resemble an obese person who must get healthy quickly or die. If we can't break up the banks by decree, they will crumble under their own weight.

Financial reform is an interest of mine and I recently encouraged Jamie Dimon, the CEO of JPMorgan Chase, to embrace the breakup of "too big to fail" financial institutions. TBTF is not an isolated issue, however. It is a symptom of a much bigger problem, that can't be resolved by willful and well-meaning actions of standalone actors – whether persons, institutions or governments. A concerted and coordinated effort of all the parties involved would be necessary for, but still won't guarantee success.

True, there's political will and public demand for reform here in the U.S. Dimon himself supports reform on some level, as he pointed out to me in an email. But if financial reform is to have any real effect then it would have to be done in sync with reforming the European banks.

I admit ending "too big to fail" is easier said than done. Let's look at the playing field. Every government or private player in the financial markets is highly specialized in its own niche; they all follow a certain playbook. The Federal Reserve can only cut or raise rates and buy or sell assets. European leaders are too busy bringing Germany and Greece to a common denominator while experimenting with austerity. Our own Congress is obsessed with tax cuts and spending cuts. But the Fed's cash is not making its way to the consumers' pockets; European austerity creates more problems than it solves; U.S. Congress is mired in gridlock.

And yet, if the efforts to mitigate a future crisis are to succeed, all of these entities would have to come together and synchronize their actions. Ben Bernanke (or his successor) would have to exercise a flawless (not too fast, not too slow) exit from the Fed's ongoing quantitative easing program. Congress would have to pass a bill that deals with real problems and not ideology. Even if we miraculously find ourselves watching President Barack Obama sign a TBTF Breakup bill, we would still have to get European regulators and legislators to implement a similar initiative.

Each one of these events is necessary, but insufficient on their own for financial reform to proceed. All of the above would have to be executed impeccably and preferably in a close and coordinated sequence. And say we do all of that. What is the probability of all of that happening in the right manner at the right time and without a glitch?

But there's a bright side, albeit with a cruel irony, to such institutional failure.  If we're powerless to break up the banks, then we're also powerless to bail them out should they fail. There will be no more bailouts, because we've simply run out of options. What can we do differently from what we're already doing now? Infuse banks with cash? Lend to them at zero rates? It's all being done now, on a massive scale.

As such, being too big itself resolves the TBTF problem in a most Darwinian manner. This is the kind of concept that Nassim Taleb describes at length in his book, "Antifragile: Things That Gain from Disorder." Like a morbidly obese person, banks have to get healthy or die. Bloated size, leverage and managerial dysfunction will do the work the public can't. If we, with all our playbooks and rules and protocols, can't take care of the system's dislocations, the system's dislocations will take care of themselves – a laissez-faire dream! In some bizarre twist of fate, Bernanke's actions that inadvertently increased banks' size can seal their fate and prove to be the ultimate break-up mechanism.