Break up the big banks
President Barack Obama pledged on Monday “to put an end to the idea that some firms are ‘too big to fail.’” Though he outlined some worthy prescriptions, he failed to face up to the very size and power of the financial institutions that makes “too big to fail” possible.
For the big have gotten even bigger since the start of the financial crisis. At the end of 2007, the Big Four banks — Citigroup, JPMorgan Chase, Bank of America and Wells Fargo — held 32 percent of all deposits in FDIC-insured institutions. As of June 30th, it was 39 percent.
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In total, they had $3.8 trillion worth of deposits as of June 30th. Compare that figure to the FDIC’s Deposit Insurance Fund, which showed a balance of just $10.4 billion on the same date.
The FDIC has been the most effective regulator since the onset of the crisis, closing down failed banks in order to limit risk to taxpayers. But its resources are woefully inadequate to deal with the largest institutions. (I am excluding the $500 billion credit line it has at Treasury; those are taxpayers’ resources, not FDIC’s.)
And that’s just the commercial banking side. These banks — especially Citigroup, Chase and Bank of America — have huge investment banking operations that are maddeningly complex and, systemically-speaking, very dangerous.
Obama certainly recognizes the problem — “the system as a whole isn’t safe until it is safe from the failure of any individual institution.”
But his recommendations — more stringent capital requirements, stronger rules and a “resolution authority” to cope with systemic meltdowns — won’t solve it once and for all.
To be sure, higher capital requirements are a very good start. They not only give banks a bigger cushion to deal with losses, they also limit the amount of credit they can flush through the system. This is a good thing: Too much credit is the air that inflates dangerous asset bubbles in the first place.
But higher capital requirements won’t make too-big-to-fail banks much smaller. At best they will penalize the biggest banks by reducing their returns on equity, giving smaller banks a leg up competitively.
A tax on assets is another good idea to discourage growth, but what we need is more aggressive action to force shrinkage.
For instance, resurrecting a version of Glass-Steagall would be highly sensible. Commercial banks have no business using their federally-insured balance sheets to finance risky investment banking operations. The two functions should be split.
And what ever happened to anti-trust laws? Among them, Citigroup, Chase and Bank of America control two-thirds of the credit card market. That stranglehold gives them significant leverage vis-à-vis consumers.
Another issue is derivatives, which Obama didn’t really address.
Notional exposure still totals tens of trillions at the biggest banks. Sure, many of these positions offset one another, but that assumes the daisy chain won’t break. To insure market integrity, the biggest players in it all have to get an explicit “there will be no more Lehmans” guarantee.
This gets to the heart of the issue. Though Obama says a return to “normalcy” means emergency rescue facilities can end, it’s a safe bet that they’ll come right back the next time we have a systemic event.
The only way to ensure we’ll never need them again is to eliminate too-big-to-fail banks. The fastest way to achieve that is to break them up.