Dean Baker: Why we must break up the banks

Paul Krugman says it isn't necessary – but breaking up financial giants would at least give us hope that things can change

Krugman argued in a column last week that breaking up the TBTF banks is not a necessary part of financial reform. Krugman pointed to the example of Canada as a country with a well-regulated financial system. Canada did not experience a financial crisis in 2008 in spite of the fact that five big banks essentially account for the whole of the Canadian banking system. On the other side, Krugman noted that the collapse of large numbers of small banks can also create a crisis, pointing to the chain of bank collapses at the start of the Great Depression.

These are valid points, but to paraphrase Dorothy in the Wizard of Oz: "we're not in Canada anymore." While Canadian banking regulation appears to have been effective thus far (we may want to see how they cope with a yet to deflate housing bubble before pronouncing it a success), Canada is a very different country from the United States. In Canada, they have had universal Medicare for 40 years. As the first President Bush used to say, it is a kinder, gentler, country.

This matters for financial regulation, because there is a level of independence and integrity on the part of the regulators in Canada that does not exist in the United States. The line in Washington is that if you want to talk to someone from Goldman Sachs, call the treasury department.
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To take an even more extreme case, the recent analysis of the Lehman bankruptcy showed that New York Federal Reserve Bank helped to hide Lehman's insolvency for months. It accepted Lehman's junk as collateral for short-term loans. This was a direct violation of the Fed's charter, which only allows it to accept investment grade assets as collateral, a definition that clearly did not include Lehman's "Repo 105s".
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http://www.guardian.co.uk/commentisfree/cifamerica/2010/apr/07/paul-krugman-break-up-banks