Steve Eisman, the hedge fund manager of Big Short fame, argued against breaking up the big banks in a NYT column today. His basic argument is that we now have things under control because the regulators have effectively limited the banks’ ability to leverage themselves. He also says that even if we wanted to break up the banks, we don’t know how to do it:

“Furthermore, no advocate of a breakup has come forward with a plan on how to do it. Large banks are global, complex, integrated institutions. Breaking them apart would be incredibly difficult, long and disruptive, and the banks might have to freeze loan growth during the process, slowing our economy even further.”

Hmmm, “no advocate of a breakup has come forward with a plan,” sounds a bit like nobody saw the housing bubble.

Okay, first Eisman raises a good point in that regulation is much better today than it was before the crisis. But those of us who are in favor of downsizing the behemoths question whether that will always be the case. After all, there is a lot of money to be gained from being able to outmaneuver the regulators.

And I’m not sure that many people would want to bet the health of the financial system on Washington bureaucrats staying a step ahead of the Wall Street gang. And in spite of improved regulation, I don’t think many people believe that the government would let J.P. Morgan or Goldman Sachs go under if they faced bankruptcy.

But let’s leave aside the merits of breaking up the banks and ask whether it could be done. There is in fact a simple way to break up the banks; let the banks do it themselves.

The idea is that the banks would be given sliding targets, say an asset cap of $1 trillion in three years, $600 billion in five years, and $200 billion in ten years. They would face large and growing fines on the amount of assets they held in excess of these caps.

For example, after three years they could face a penalty of 1 cent for every dollar in assets they held in excess of $1 trillion. This means that if JP Morgan still has a level of assets near its $1.6 trillion current level after the first deadline it would pay $6 billion a year in penalties. The penalty could rise to 1.5 cents on the dollars for assets over $1 trillion at the point where the $600 billion ceiling took effect. In that case, they would be paying a penalty of 1.5 cents on their assets above $1 trillion and 1 cent on their assets between $600 billion and $1 trillion.

This sort of penalty structure would give J.P. Morgan and the other big banks enormous incentive to downsize themselves. They would presumably know how to break themselves up in a way that maximized the value to shareholders, minimizing the risk of disruptions to the economy.

It is also worth remembering that the megabanks we see today are a relatively new story. They came about from a wave of mergers among large banks in the 1990s and the last decade. In many cases the simplest route to downsizing may be just reversing some of these mergers, but that would be for the banks to decide.

Anyhow, we can argue whether downsizing the big banks is a good policy. The arguments posed by Eisman are reasonable. But we should not have to worry about whether downsizing is possible. We know how to do it if we want to.