Arnold Kling makes a compelling case for breaking up the big banks in the interest of furthering free market capitalism. In his article he considers the loss of efficiency that breaking them up might incur as well as the effect on systemic risk, arriving at the conclusion that the adverse consequences of big banks to the political economy argues in favor of dismantling them.

Notwithstanding the good intentions of policymakers, who no doubt plan to create a stronger regulatory apparatus going forward, large banks will inevitably have too much power for the apparatus to govern them. They will shield themselves from its attentions by making political concessions on lending practices. So long as big banking is conjoined to big government, that is, we risk a return to the regime of private profits and socialized risk.

I would prefer a completely hands-off policy when it comes to financial markets, but the political reality is that deposit insurance and regulation are not going away. Given that they are not, the worst possible outcome is that the marriage of politics and finance evolves into outright corporatism, as it did with Freddie Mac, Fannie Mae, and the rest of the nation’s largest financial institutions. And that evolution is directly attributable to the influence that comes from banks’ being big enough to achieve real political power. To expand free enterprise, shrink the banks.

Kling’s arguments, coming as they do from a committed free market libertarian/conservative carry a force that I, personally, find lacking in similar arguments advanced by the Progressive side of the aisle. I could be wrong but I don’t discern a government command and control agenda that seems part and parcel of the liberal argument. Essentially, they seem to offer the substitution of government’s stifling embrace as an antidote to the headlock that the banks now employ.

Unasked and unanswered in his post is the question of how you get to smaller banks. It seems that any highly involved technocratic solution would ultimately loop back to the status quo. The more that government tries to control the banks through regulation, and yes even shrink them in that manner, the more likely it is that the regulators and the regulated will reach accommodations that change little.

Simply reducing the amount of leverage that banks are allowed to employ in their business seems the best course. Set at a proper level a number of their activities would no longer be economic and would properly migrate to other business entities that do not rely on government safety nets. There would be little need for complex regulation which would inevitably be gamed and the attendant reduction in gross profitability would necessarily require the banks and their shareholders to bargain over the distribution of revenues between the owners and employees.

I hope that Kling’s thoughts gain some traction. I doubt that they will.