Now that Congress and the Obama Administration have succeeded in making U.S. health care even worse than it was before--which result, when it becomes evident over the next few years, will simply become an excuse for still more counter-productive, government intervention--they will no doubt set their sights on"reforming" the financial system. One idea that has appealed even to some market advocates is breaking up the big banks. Doing so would allegedly undermine"too big too fail" both directly and indirectly, by reducing the political clout of large institutions.

So I was intrigued to notice that the most recent, 2010 edition of Frederic S. Mishkin's standard money and banking text, The Economics of Money, Banking & Financial Markets, observes that, despite the increased consolidation of the U.S. banking industry over the last twenty-five years, it still remains the least concentrated in the developed world. Mishkin, although no market fundamentalist by any stretch of the imagination, writes that"in contrast to the United States, which has on the order of 7,100 commercial banks, every other industrialized country has far less than 1,000. Japan, for example, has fewer than 100 commercial banks . . . even though its economy and population are half the size of those of the United States."

Not only does the U.S. have more banks, but they tend to be much smaller. In Mishkin's list of the ten largest banks in the world as of 2008, not a single one was from this country. They were all from the UK, Germany, France, Switzerland, the Netherlands, or Japan. Admittedly the list only focused on the assets of commercial banks per se, and not of their holding companies. And the subsequent bailout and Fed ballooning of bank reserves by nearly $1 trillion has pushed two U.S. banks into the Bankers Almanac list of top ten for 2010: JP Morgan Chase at seventh place, and Bank of America at tenth.

Yet these facts so far have not even been mentioned in the debate over financial reform. As nearly every knowledgeable economic historian concedes: the past, misguided restrictions on branching, dating back to before the Civil War and making the U.S. banking system the most fragmented in the world, also made it the most fragile, vulnerable to its record number of bank panics. Indeed, the U.S. system of unit banking was one of the major factors that contributed during the Great Depression to the worst banking crisis in world history.

Is it possible that some U.S. banks now exceed the optimal size from the standpoint of economic efficiency? We can expect that kind of simple-minded conclusion from the likes of Joseph Stigliz, but even Alan Greenspan, in a recent paper on"The Crisis," has stated:"Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution." How sad that an alleged defender of free markets would even imply that it is the market's fault when it does not conform to some Fed paper's estimate of what is efficient. Why did these large banks emerge in the first place if they did not capture some economic gain?

If large banks are indeed economically inefficient, this would normally create opportunities for hostile takeovers which could profit by breaking the big banks up. But of course, the same critics who decry markets for creating principal-agent problems between managers and shareholders are often the most strident opponents of corporate takeovers, the markets effective solution to such problems. All corporate mangers, of course, enjoy the partial protection of the federal Williams Act of 1968 and assorted state impediments to hostile takeovers, but less well known is the fact that control over financial institutions is strangled within a still more onerous and convoluted web of protections. The bottom line is that a hostile takeover of any inefficiently managed large bank is all but impossible for non-financial parties, and even when attempted by another financial institution, must virtually be orchestrated by the regulators themselves.

An article by James A. Wilcox in the November 2005 issue of San Francisco Fed's Economic Letter hints at a revealing possible explanation for large banks."Government policies may also increase the economies of scale that depositories face. Recent legislation, such as the Gramm-Leach-Bliley Act, the USA Patriot Act, and the Bank Secrecy Act, may . . . have the effect of imposing various sizable costs that are borne disproportionately by the smaller depositories. Such disproportionate, law-induced costs would increase the returns to scale in the banking and credit union industries and thereby strengthen the motives for consolidation." Although this line of research has not, so far as I know, been followed up on, it coincides with an anecdotal observation that one of my students who then worked in the banking industry made years ago. She reported that at least one-third to one-half of her work time and that of her fellow employees was devoted to complying with various government edicts.

So there you have it: the exact same pattern as health care. Government coercion creates unintended outcomes that become the justification for more government coercion that will have even worse unintended consequences down the road. Playing the game of trying to alleviate problems created by some interventions with other offsetting interventions runs up against the hubristic folly of central planning. No one knows enough to do that wisely and effectively, even in the rare cases where it might be politically feasible. If U.S. banks are indeed too big because of stupid government regulations (something we can never know with absolute certainty), then the solution is to repeal those stupid regulations, not break the banks up with more stupid regulations.