Sandy Weill’s comments this week are just the latest dustup in the debate about the existence of financial institutions that are labeled by regulators and market participants as being too big to fail. Despite the criticisms leveled at these firms, the largest banks have only gotten bigger over the last few years – and U.S. regulators still appear underprepared to resolve a future failure of a systemically important financial institution without setting off broader market panic.
Against this backdrop, new bank reform proposals are likely to get a lot more attention on Capitol Hill heading into the November election. Catalysts for this debate are sure to include the stories around JPMorgan’s London Whale trader and the brewing Libor scandal.
In a recent paper, academics Frederic Schweikhard and Zoe Tsesmelidakis examined the borrowing advantage that large financial institutions had from 2007 to 2010 as result of the market’s perception that their liabilities were backed by the federal government. Taxpayers subsidized TBTF banks to the tune of $130 billion, according to their findings. Citigroup was the single biggest beneficiary of government support, totaling $50 billion, but even well capitalized JPMorgan is estimated to have gained $10 billion in value from taxpayer guarantees.
Privately, the big banks think this is old news. They are quick to note that Congress addressed the issue of taxpayer bailouts back in 2010, when it passed the 2,000-page Dodd-Frank financial reform bill. Among its many directives, the law created a new systemic risk council of regulators and tasked it with designing and implementing a new “resolution regime” for big and complex financial institutions. The goal was to empower a new council to regulate and oversee the failure of future financial institutions and to guard against taxpayer guarantees or systemic consequences for the overall economy. While it’s certainly debatable whether Dodd-Frank achieved some progress in this area, credit rating agencies are still signaling to the market that the government would likely step in and protect bank creditors. As long as this is true, big banks continue to have a borrowing advantage. Even granting additional discretion to regulators solves nothing if economic vulnerabilities still make a bailout the less harmful choice when the next crisis arrives.
During the debates this fall, Mitt Romney will surely confront President Obama on the limitations of the financial reforms that his administration advanced, including the Dodd-Frank Act. The TBTF problem stands above all others in this area and presents an opportunity for a defining contrast before the election. A new choir of analysts – including those on the right that are steeped in both policy and political strategy – are also starting to argue that what looks like good policy on the big banks might also be good politics (see here and here and here).