The Dodd-Frank law attempts to outlaw bail-outs of huge banks that would otherwise be considered “too big to fail,” meaning that they are so large that their collapse would threaten not just the U.S. economy but the global financial structure as well.
(The banks in question are JP Morgan Chase, BankAmerica, Goldman Sachs, Citigroup, Wells Fargo and Morgan Stanley.)
But the fact remains that those six banks are still, in fact, too large to be allowed to fail, and everyone in banking knows it even if they do not admit it. Attorney General Eric Holder has acknowledged that the banks may even be “too big to prosecute,” because again the economic impact of doing so would be enormous:
“I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy.”
Banking regulators in the United Kingdom are dealing with similar issues.
So what do we do? Influential voices are being raised to again attempt to address the problem.
Federal Reserve Chairman Ben Bernanke said Wednesday that he still views “too big to fail” banks as a “major issue” that must be addressed….
“I don’t think ‘too big to fail’ is solved now. We’re doing a number of things which I think will help,” he said. “If we don’t achieve the goal, I think we’ll have to do additional steps … it’s not just something we can forget about.”
“Too big to fail was a major source of the crisis, and we will not have successfully responded to the crisis if we do not address that issue successfully,” he said.
Perhaps the most prominent and vocal advocate of addressing the “too big to fail” problem has been Massachusetts Sen. Elizabeth Warren. Bernanke was blunt in his comments yesterday, saying that “I agree with Elizabeth Warren 100 percent that it’s a real problem.”
But here’s the thing. Some important conservatives also recognize that it remains an issue. As Sen. David Vitter, Republican of Louisiana, put it in a Senate hearing this week, “My top concern is actually the same as Mrs. Warren’s. There is growing bipartisan concern across the whole political spectrum about the fact that too big to fail is alive and well.”
Last week at CPAC, Richard Fisher, head of the Dallas Federal Reserve and a conservative voice on the Fed board, made a similar argument in a sparsely attended speech. As the Wall Street Journal reports:
“Dealing with too-big-to-fail banks is a cause that should be embraced by conservatives, liberals and moderates alike,” Mr. Fisher said. “The American people will be grateful to whoever liberates them from a recurrence of taxpayer bailouts.”
Staying away from monetary policy, Mr. Fisher used his speech to again argue that in the wake of the financial crisis, the problem of bank concentration has only gotten worse, and that the Dodd-Frank financial reform legislation that was supposed to help fix the problem didn’t. He said the cores of banks have gotten so large that their failure would be a major risk to the system.
The idea that a revised set of regulations that would downsize banks and allow them to more easily pass through bankruptcy is a fix for the banking system didn’t sit well with some at the event.”
The problem, at its core, is that smaller banks will be allowed to fail and they know it, a fact that injects a degree of caution and risk-assessment into their operations. At larger banks, such as JP Morgan, under fire for allowing the loss of $6 billion in high-risk derivative gambling, that risk does not exist, because bank officials and regulators alike understand that if the bank goes under, the economy goes with it.
That knowledge allows those banks to take high-profit risks that smaller banks cannot, further cementing their advantage through what amounts to a government subsidy. In effect, they are immune to market discipline and they know it.
“The current system “makes for an uneven playing field, tilted to the advantage of Wall Street against Main Street, placing the financial system and the economy in constant jeopardy,” as Fisher said.
As the WSJ report notes, some conservatives at CPAC and elsewhere are unconvinced, because the solution to “too big to fail” is government intervention, forcing those banks to reduce themselves in size or face significantly tighter regulations on their operations. But as conservatives who look at the issue in practical rather than ideological terms understand, you have three choices:
1.) Intervene now, in relatively mild ways, to prevent those banks from indulging in high-risk trades that threaten their bottom line and in turn the economy.
2.) Wait until the inevitable happens again, when overconfident bankers take on more risk than they should in search of huge profits and bonuses, and then bailout the banks out again through a TARP-like intervention.
3.) Do nothing, which amounts to playing a game of chicken with the big banks. They will continue to take big risks, the federal government will continue to claim that they will not be bailed out when they falter. Then, when the crisis comes, allow them to go down and take the rest of down with them.
Option 1 is clearly the lesser of three evils. But our political system seems to have lost the capability to make decisions on that kind of basis.
– Jay Bookman