After I complained the Administration was shining us on about why we should allow too-big-to-fail (TBTF) banks to exist, the Administration, unfailing readers of strawmen, sent the hapless Larry Summers to PBS News Hour to explain to the unsophisticated that if we broke up the megabanks and instead had many smaller regulated banks, it would be the end of America and the financial industry as we know it.

As Paul Krugman says today, "so?"

From the PBS interview with Jeff Brown:

Brown: The too big to fail issue, why not go further? Why not just limit the size of banks?

Summers: Jeff, that was the approach America took to banking before the depression. That was the approach America took to lending in the thrift sector, before we had the S&L crisis. Most observers who study this believe that to try to break banks up into a lot of little pieces would hurt our ability to serve large companies, and hurt the competitiveness of the United States. But that’s not the important issue, they believe that it would actually make us less stable. Because the individual banks would be less diversified, and therefore at greater risk of failing because they wouldn’t have profits in one area to turn to when a different area got in trouble. And most observers believe that dealing with the simultaneous failure of many small institutions would actually generate more need for bailouts and reliance on taxpayers than the current economic environment.

Funny, I always thought the smaller bank system, if that’s what it was, failed because Wall Street wasn’t sufficiently regulated, and the local bank runs happened because we didn’t have the FDIC at the time. So is Larry now saying that having the FDIC to take over smaller bank failures has been a failure?

And what’s he saying about needing diversified megabanks that lose money on risky stuff but loot, uh, borrow money from better managed activities? Surely he doesn’t mean to argue for letting the investment casino borrow from the government-guaranteed deposit-based divisions?

And the stuff about needing megabanks to do megadeals runs counter to economists, including those at the Federal Reserve, who can’t think of any reason why banks need to be much bigger than $100 billion assets, not 10 to 25 times that large.

Meanwhile, Paul Krugman seems to be having a Road to Damascus moment. After suggestions earlier that he didn’t think breaking up the TBTF banks got to the core problems that caused the meltdown, he now seems much more worried about the political power, influence and corruption of Larry Summers’ friends:

The fact is that Mr. Obama should be trying to do what’s right for the country — full stop. If doing so hurts the bankers, that’s O.K.

More than that, reform actually should hurt the bankers. A growing body of analysis suggests that an oversized financial industry is hurting the broader economy. Shrinking that oversized industry won’t make Wall Street happy, but what’s bad for Wall Street would be good for America. . . .

What’s the matter with finance? Start with the fact that the modern financial industry generates huge profits and paychecks, yet delivers few tangible benefits.

. . .

These profits were justified, we were told, because the industry was doing great things for the economy. It was channeling capital to productive uses; it was spreading risk; it was enhancing financial stability. None of those were true. Capital was channeled not to job-creating innovators, but into an unsustainable housing bubble; risk was concentrated, not spread; and when the housing bubble burst, the supposedly stable financial system imploded, with the worst global slump since the Great Depression as collateral damage.

Yesterday I was upset because the Administration was not being straight with us. Now they’re telling us what they really think, it’s worse. These guys love Wall Street’s megabanks, so they’re shielding them, even though they’re still looting the country. And when top advisers sound just like Jamie Dimon, it’s like they’re already half way out the revolving door.

More:

HuffPo, Shahien Nasiripour, Larry Summers Defends Megabanks
Rortybomb/Mike Konczal: Six things worth fighting for in the Senate bill
Simon Johnson: The consensus on big banks starts to move
HuffPo/Robert Kuttner, reports on Dems splitting over whether to compromise to get Republican votes

Update: DeLong cites a study suggesting some bank concentration can => greater stability. Huh.

Update II, Friday night: Krugman has been exploring the related topic. Is he saying a concentrated market appears stable while it works as an "unintentional ponzi scheme," which seems stable until it blows up?

So I’d suggest that what we did between 1980 and 2008 was to replace a financial system in which profits were created by lack of competition with a system in which profits were created by misinformation and misperceptions — a giant, if mostly (not entirely) unintentional Ponzi scheme, which finally went bust.

I don’t think this is an argument for not breaking up the monsters. And what if it’s not "unintential" but collusion?