Why not Baby Banks?

Jan 25, 2010 20:01 UTC

The President is right to target firm size if he wants to insure no financial firm can cause a system failure. Yet despite clear evidence that banks are already too big, Obama’s proposal won’t cut them down. It would only limit future growth by acquisition.

Specifics are being worked out, but what is clear is that Paul Volcker’s “size” proposal will limit future growth by acquisition only. It won’t force existing firms to shrink nor limit their ability to grow organically.

But if Obama wants to end the too-big-to-fail paradigm, if he wants to eliminate the possibility that one firm’s failure could cause a cascading financial collapse, he needs to engineer a system with more circuit breakers. Shrinking banks is crucial.

Like the power grid, the financial system is huge, dynamically complex and interconnected. A single point of failure can cause a cascading collapse. In 2003, some overgrown trees in Ohio were enough to cause a blackout that hit 55 million from Ontario to New York. In 2008, the failure of any one of a handful of financial firms could have plunged the economy into Depression.

True, size isn’t the only factor contributing to systemic risk. Yet despite thousands of bank failures during the savings and loan crisis, there was never a risk of systemic collapse because no bank was large enough to crash the system.

Another counter-argument is that gross balance sheet size isn’t by itself an indicator of risk. Certainly some balance sheets are riskier than others, but there remain 10 to 20 in the United States, of varying risk profiles, that are systemically dangerous.

Some argue that shrinking big banks would eliminate efficiencies. While size may have first order benefits, recent events show these are outweighed by second order bailout costs.

Nor do we need large banks to finance large deals. Big loans can be handled via syndication.

No doubt it would be tough to break up big banks, but we’ve done something similar before. Standard Oil and AT&T were split into Baby Oils and Baby Bells. Why not figure out a way to split too-big-to-fail financials into Baby Banks?


too sensible and simple ! and for added measure , lets just establish a naational limit on leverage at all banks to say 10×1 . Then they can’t start growing on steroids again .

but then Obama can’t whip up anti-bank sentiment among the looney left and there is no way that Congress gets to milk this idea for money ( ie no new taxes ) so it’ll never see the light of day .

Posted by divvy trader | Report as abusive

The Ascent of Volcker

Jan 21, 2010 20:30 UTC

So, wow, the Obama administration has reacted very quickly — perhaps too quickly — post the Massachusetts Senate election. After proposing a tax on bank liabilities, Obama is taking an even tougher line, adopting recommendations from Paul Volcker that banks be limited in their size and scope.

Before getting to specifics, it’s worth noting how Geithner and Summers appear to have lost favor. In the preamble to the proposal, Obama mentions neither of them. And when he announced the plan he did so with Volcker and Bill Donaldson standing behind him…Geithner and Summers were off to the side. Could the duo be headed for the exit?

But back to the proposals themselves. Unfortunately they are very vague:

1. Limit the Scope – The President and his economic team will work with Congress to ensure that no bank or financial institution that contains a bank will own, invest in or sponsor a hedge fund or a private equity fund, or proprietary trading operations unrelated to serving customers for its own profit.

In his prepared remarks, Obama called this first proposal the “Volcker Rule,”

2. Limit the Size – The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.

These are good ideas, but until we see the details it’s hard to offer unconditional support.

The idea behind the first proposal is that since government insures bank liabilities, it must control bank assets. Bank liabilities are insured explicitly via deposit insurance and implicitly, for the biggest banks, via a general too-big-to-fail guarantee. Deposit insurance is the only one of those two that is defensible and its purpose is to protect the integrity of the payments system. Currently banks use this insurance to obtain cheap funding that supports risky side businesses, like proprietary trading.

But how will prop trading be defined? Will banks actually have to split up? Will they merely have to tweak their corporate structure?

As for the proposal regarding bank size, it doesn’t appear that there will be much to it. Banks won’t have to get smaller or even stop growing. Instead the new rules will just prevent bigger banks from making (any?) acquisitions. They’ll be able to continue growing organically. This probably isn’t enough to reduce systemic risk, unless other reforms can successfully reduce risk-taking. (Personally I think we should break up the banks into baby banks the way we busted AT&T into baby bells….so that none is so large as to be impossible to resolve in a crisis.)

It looks a little clumsy, putting out a plan this short on detail. That said, it seems to mark a clean break with the ridiculous policy that somehow protecting the banks protects America.

The real test for Obama’s leadership, by the way, will probably come if a substantive plan like this passes. Forcing banks to make big changes to their balance sheets will surely crimp the economy in the short-run as it makes it more difficult for banks to extend credit.

That’s not a bad thing. Either we do it proactively in order to contain risk, or we let the system blow itself up again. The latter course will lead to more credit destruction of course. But asking people to voluntarily subject to economic pain will be tough. Hopefully Obama sticks to his guns.


The markets resposne is a good sign…it says that this is going to change the way banks make their profit.

The present system stinks. Investment banks getting bank status to get a credit line from the fed then hyper-leveraging their free money to make big bucks. Not a lot of skill to that!

Soros and Volcker are right. You need the right regulation that takes out the moral hazard. Investment banks should get their money from the Private sector and Commercial banks should get their money from the Fed(public). This way the Commercial Banks serve as a firewall between riskless funds and Investment bank speculation. And it forces IBs to speculate carefully because they have to invest a lot of capital and energy to convince investors in their magic. What could be wrong with that? This could be the first good policy from Obama.

As Winkler notes, the sacred cow theory of the financial markets is a lot of bull. A false belief. Because the financial system is not a free market, it is structured by government policy and regulation. That regulation needs to be changed. Adjust leverage margins to reasonable levels and pull the Fed’s capital subsidies from IBs.

This crisis was created by overleverage and the inversion of risk. So, put a cap on leverage and get the IBs back in the business of managing real risk. Simple, eh?

Posted by DrSavage | Report as abusive

Lunchtime Links 1-19

Jan 19, 2010 19:18 UTC

MUST READSouring mortgages, weak market put FHA on tightrope (Timiraos, WSJ) Good article, though Timiraos doesn’t address the absurd circularity perpetuated by FHA Chief David Stevens when Stevens says, on the one hand, that more gov’t lending protects the housing market from further declines, while simultaneously arguing that such lending isn’t sustainable. That said, Timiraos has worked lots of interesting stuff into this piece, especially towards the end. For instance, in late ’07 investors were refinancing at-risk borrowers into FHA loans in order to shift risk to taxpayers. Barney Frank defends permanently raising FHA maximum loans for certain geographies to $729k. Also lots of data about how badly FHA loans are performing.

Citi’s Q4 earnings: Not terrible but not great (Wilchins, Reuters) Trading revenues in the investment bank were much weaker compared to last quarter. Citi also benefited from a tax break, without which they wouldn’t have met consensus estimates for the quarter. Here’s a helpful chart.

(Click here to enlarge in new window)


How the French outplayed AIG and the Fed (Berman, WSJ…subscription req’d) Great column. Goldman gets all the bad press, but it was far from the only bank that got 100¢ on the dollar for derivative contracts with AIG…

Too big to fail is here to stay (Salmon, Reuters) Felix does a great takedown of Andrew Ross Sorkin’s latest column.

Record cash means S&P 500 at half 2007 valuation (Xydias/Nazareth, Bloomberg) A very interesting idea, though lots of bones to pick with the way this piece was written. In nearly 1,300 words the writers never manage to provide a solid definition of how they’re computing valuation. What is price to cash flow? Do they mean price to free cash flow? Do they mean price to EBITDA? There’s a line about cash flow being earnings plus depreciation and asset writedowns. That may be a very relevant metric. But it’s not one that investors know or understand and the authors fail to explain it.

The bidding war for failed banks (Mathews/Fisher, SNL) Interesting data on competitive bids for failed banks. (Until FDIC stopped releasing it)

In defense of a 4-day workweek (Hari, Independent)

Google at war in China, now postpones handset launches (BBC)

Another Swiss bank whistleblower (Browning, NYT)

AT&T/Verizon cut prices (Furchgott, Gadgetwise) The price cuts are just for some voice plans, not data plans. You can call the carriers and get the new lower prices without having to extend your contract…


No, Ron, they didn’t. It happens for balance sheet periods beginning on 1/1/10. So the Q1 release will be the first to include it.

Posted by Rolfe Winkler | Report as abusive

Move your money

Dec 30, 2009 18:05 UTC

Arianna Huffington and Rob Johnson are organizing a big bank boycott. They want depositors to take their money out of Too-Big-To-Fail banks and put them in smaller, high quality banks.

They’ve launched a new website and have teamed up with Chris Whalen to give folks other options. Whalen’s firm, Institutional Risk Analytics, has a proprietary system that grades banks using FDIC data. Enter your zip code and Whalen provides a list of high quality banks in your area.

It’s a potentially powerful combination. Huffington has wide reach due to her media ubiquity and popular website. Johnson, once a portfolio manager for George Soros’s Quantum Fund, is a successful veteran of high finance who’s spoken out against the danger of derivatives and will head Soros’ $50 million Institute for New Economic Thinking. Leveraging Whalen’s data means the two can do more than simply ask folks to move their money. They can provide better options.

(You can read more about it in this column published at HuffPo.)

I applaud the effort and plan on taking them up on it. Some of my savings currently reside at a TBTF bank, earning nothing, and I plan to move the account shortly.

When bloggers like me talk about creditors holding banks responsible for the risk they take, that includes bank depositors. If you have deposits in a bank — a CD, checking or savings account, for example — you are a creditor of your bank. Moving your deposits out of banks that benefit from too-big-to-fail guarantees is a tangible way you can protest bailouts.

I do have one small quibble with the Huffington/Johnson site, in particular the YouTube video they’ve produced. The idea that fat cat bankers — “Potter” from It’s a Wonderful Life stands in — are solely responsible for the crisis oversimplifies the issue. Plenty of smaller banks have gotten themselves into trouble with irresponsible lending. FDIC’s problem bank list now stands at 552, composed mainly of smaller banks.That’s 7% of all FDIC insured institutions in case you’re wondering.

It also lets the rest of us off the hook. Without willing investors and an assist from Alan Greenspan’s low rates, big banks couldn’t have inflated the bubble. Yeah, many should have known better. But let’s face it, Wall Street bankers aren’t the only ones that are greedy.

I also worry that big banker baiting could lead to violence if/when the financial sh*t again hits the fan.

But again, that’s a small quibble. Huffington/Johnson/Whalen — all great folks I’ve had the chance to speak with in the past — are spot on with this effort.

What truly separates community bankers from the big boys is that they can fail. If they mess up, they end up in FDIC receivership. If they lose, they pay for their own mistakes. That’s why this effort should hold particular appeal to financial conservatives.

If it weren’t for the moral hazard created by deposit insurance, depositors would flock to banks that lend conservatively. In the meantime, the best thing we can do is take our money out of quasi-public banks like Chase, Citi, Wells, BofA, Ally, et al and move them to banks that operate free of government support.

More at Move Your Money.


If you plan on moving away from the “Big Banks” , look over the Credit Unions with easy terms to join. (Some are Very easy to get a account with…)

Ken N.

Posted by Ken N. | Report as abusive

Politics and bank regulation don’t mix

Dec 8, 2009 13:28 UTC

The Federal Deposit Insurance Corp tried to seize and sell Cleveland thrift AmTrust last January but local politicians intervened. In the end, the bank still went bust 11 months later – a delay that may have increased losses to the U.S. regulator’s funds. As Congress debates banking reform, AmTrust provides a useful warning that the regulatory apparatus needs to be kept free from politics.

Regulators had known for some time that AmTrust was troubled. AmTrust’s chief regulator turned down the bank’s request for TARP money last fall. It also hit AmTrust with a cease-and-desist order, instructing management to change lending practices and boost capital by December 31. When AmTrust missed the deadline the FDIC decided to step in.

But Ohio Congressman Steven LaTourette and Cleveland mayor Frank Jackson convinced Treasury and the White House to keep the regulators at bay. Bythe time FDIC finally seized AmTrust on Dec. 4, its tangible common equity – the capital it has to withstand loan losses – had fallen to $276 million from $943 million the year before. The cost of the bank’s failure to FDIC: $2 billion.

The price tag to the FDIC would’ve been lower had it acted sooner, according to the Wall Street Journal. This isn’t a new lesson. Congress established the Prompt Corrective Action doctrine in 1991 because the S&L crisis taught that to limit the cost of bank failures, it’s important to seize troubled institutions quickly, while they’ve still got capital.

And the importance of speedy resolution is more pronounced with larger firms, whose deterioration can infect the entire system. Remarkably, Congress is poised to erect new political barriers that may delay pre-emptive action to corral systemically dangerous firms.

An amendment offered by Rep. Paul Kanjorski to Barney Frank’ s Financial Stability Improvement Act would require Treasury to sign off on corrective actions imposed by regulators on firms with greater than $10 billion of assets. For $100 billion+ firms a White House signature would also be needed.

AmTrust was small enough that its collapse didn’t pose a systemic threat. At worst, it just compounded losses at FDIC, which may require its own taxpayer bailout before too long. With systemically dangerous firms, however, the cost of political delay will be much higher.


From what I understand, the Fed says it didn’t have the tools to handle the collapse of these firms. They aren’t asking for the authority to do so. But they do point out that because of a lack of any processes to unwind those companies the Fed had to keep the financial system afloat or the resulting defaults would have cause a depression on a global scale.

Mr Bernanke Pointed out that during the depression the banks were allowed to simply fail. And the resulting defaults cascaded causing a global down turn. He said that in order to prevent a repeat, some choices needed to be made to support the banks. If I understand history correctly, there was no financial social safety net in place during that time either.

I think it would have been easier and cheaper to keep the citizens afloat than it has cost us to keep the banks up. It also would have put the banks in a position of accountability to the citizens. Citizens with money can choose what sectors of the economy to support by choosing where to spend. It’s just incomprehensible to me that even though the citizenry is the engine of the economy, the engine is never given any fuel.

It’s like wanting to keep harvesting fruit from a tree that never gets watered. Eventually the tree dies and there is no fruit to be had. We are strangling our people with poverty. We are cutting off our own heads by keeping our people uneducated and sick, while expecting them to labor tirelessly. Our future slips away with each failed generation. It’s time to think about the citizens.

Poole on fixing TBTF

Nov 29, 2009 14:43 UTC

William Poole, the last President of the St. Louis Fed and now with the Cato Institute, has a good piece on fixing the TBTF problem in a recent issue of the Financial Analysts Journal. Based on a speech given last April, it’s still highly relevant.

Poole doubts that new resolution authority will end TBTF. When push comes to shove, regulators are more likely to bail out the next AIG or Lehman rather than attempt an “orderly” wind down, even if they have expanded authority to resolve holding companies.

Poole says four problems must be solved:

First, many firms have too little capital relative to the risks they run. Unfortunately, capital inadequacy is often revealed only after the fact. We need arrangements that force banks to hold more capital than might seem necessary. Second, banks need long-maturity capital that cannot run. Third, we need to rely more on market discipline to deny funds to banks deemed risky. Fourth, when a bank needs to be restructured, the bank, rather than the federal government, should manage the restructuring.

Perhaps the best way to reduce leverage would be to get rid of the tax incentive to max it out, ending the deductibility of interest on business and personal tax returns. Easier said than done, of course. The lobbying effort to stop such a reform would be huge. So Poole proposes that the transition be “smoothed.”

…interest deductibility could be phased out over the next 10 years. Next year, 90 percent of interest would be deductible; the following year, 80 percent would be deductible, and so forth, until interest would no longer be deductible at all. The same reform would apply to all business entities; partnerships, for example, should not be able to deduct interest if corporations cannot.

With this simple change, the federal government would encourage businesses and households to become less leveraged. We have learned that leverage makes not only individual companies more vulnerable to failure but also the economy less stable. We use tax laws all the time to promote socially desirable behavior; eliminating the deductibility of interest would reduce the risk of failure of large companies—especially, large firms—and thereby reduce the collateral damage inflicted by such failures.

As for dealing with capital inadequacy and maturity mismatch, Poole says banks should be forced to hold “a substantial block of subordinated long-term debt in their capital structure.” To discourage growth of large firms, a bank with total assets over a certain threshold…

…would have to issue subordinated debt equal to 10 percent of its total liabilities. The debt would consist of 10-year uncollateralized notes that were subordinated to all other debt obligations of the bank. With 10-year notes equal to 10 percent of the bank’s total liabilities, the bank would have to refinance one-tenth of its subordinated debt every year, equal to 1 percent of its total liabilities. The subordinated debt would be in addition to existing requirements for equity capital.

Subordinated debt has several important advantages. We have seen that banks do not have an adequate cushion against losses under current capital requirements. If taxpayers are to be expected to stand behind our giant banks, they deserve a larger cushion against the banks’ mistakes. More importantly, because banks would have to go to the market every year to sell new subordinated debt, they would have to convince the market that they are safe. A bank that found selling new subordinated debt too expensive would have to shrink by 10 percent.

Restructuring a bank at an annual rate of 10 percent is perfectly feasible, and the restructuring would be managed by the bank and not by the government.

A subordinated debt requirement hasa significant advantage over a higher equity capital requirement, which is one of the regulatory changes being discussed. A subordinated debt requirement entails much more market discipline because a bank must either go to the market every year to replace maturing debt or shrink. If a bank’s prospects appear poor to investors, its stock price will decline and it may be unable to sell more equity. But it is not forced to shrink under these circumstances, nor will regulators necessarily force a bank to shrink. Market discipline through subordinated debt would be much more rigorous than any discipline regulators are likely to apply.

Poole is basically in Sheila Bair’s camp about forcing creditors to face losses. Bair is a supporter of the Miller-Moore amendment to the financial reform bill, which would give FDIC the power to impose a haircut on secured creditors of a large financial firm that ends up in receivership. That’s a good idea and I hope it’s signed into law.

But it’s still a reactive way to shrink big banks. What we need are pro-active solutions that force banks to shrink before they get into deep trouble. Poole says his idea would accomplish this. I invite reader comments on whether it would or not…

There’s more in the article.


I think, if banks are not able to deduct interest paid on deposits, that such a change would be equivalent to not allowing Nucor to deduct the expenses of purchasing raw materials.It would certainly making borrowing more expensive.

Posted by Andrew | Report as abusive

If banks can delay, pray

Nov 24, 2009 17:51 UTC

The “too-big-to-fail” amendment offered by Representative Paul Kanjorski has good intentions, but fatal flaws.

One I wrote about on Monday. Another is a section (see page 7) that gives systemically dangerous institutions (SDIs) the right to appeal regulatory orders in a federal district court. If they don’t like the corrective actions that regulators instruct them to take, they could delay them indefinitely.

With bank resolutions, the key issue is speed. We learned that the hard way during the savings and loan debacle. Allowing banks to deteriorate until they have no capital left is like waiting for an infection to turn gangrenous before treating it.

With most companies, that’s not a problem for anyone but shareholders and creditors. But banks aren’t like other firms. Society provides them a strong, and expensive, safety net. And that safety net has expanded significantly in the last year.

In exchange, we rightly subject them to more stringent regulations. We guarantee their liabilities, after all, so we’ve the responsibility to control their assets.

As Ed Kane of Boston College told me: “We support them the way parents support children. It’s our responsibility to discipline them.”

So that regulators have the power to act quickly against plain-vanilla banks, Congress established the Prompt Corrective Action doctrine in 1991. It gives bank regulators extraordinary power to put the screws to banks before they dig themselves too deep a hole.

Banks may consult with regulators on what needs to be done. But the only judicial review available to them is through the court of appeals, which must review the administrative record of corrective actions that regulators have already instructed banks to take. And it must do so in an expedited manner, typically 30 days.

A similar doctrine to break up SDIs proactively is what many had hoped Kanjorski would propose. But the judicial review process it envisions would turn corrective actions into the SDIs’ shield, rather than the regulator’s sword.

For one thing, it would allow SDIs to challenge their regulator in a district court, not the court of appeals. A district court’s review wouldn’t be limited to the administrative record; it would likely include a trial by jury. First of all, this would involve a lengthy discovery process. And systemically dangerous institutions typically have the best, most expensive lawyers in the world. While regulators are tied up, they would have an even stronger incentive to engage in morally hazardous behavior, to shift losses to the safety net while looting whatever value is left in the institution.

Just look at the billions in bonuses that Wall Streeters paid themselves last year after their balance sheets were rescued by taxpayers.

Professor Bill Black of the University of Missouri Kansas City worries Kanjorski’s judicial review process would effectively turn the district judge and jury into the regulator, a position for which they have no expertise. Would a North Carolina jury instruct Bank of America to take corrective actions that could lead to thousands of lost jobs in their area? Probably not.

Black says Kanjorski can improve his amendment by limiting SDIs’ judicial recourse to an expedited review of the administrative record in front of the court of appeals.

Kanjorski’s head is in the right place, even if his legislation is flawed. We need a new regime that encourages regulators to break up big banks before they threaten to bring down the system.

But his amendment makes the process too difficult. Already it erects a big roadblock by telling regulators they can only take action if an SDI “poses a grave threat to the (nation’s) financial stability or economy.”

By the time regulators realize a firm poses a grave threat, it’s probably too late to do much about it. And if the firm can delay action indefinitely by going to a district court, then what’s the point?


“And if the firm can delay action indefinitely by going to a district court, then what’s the point?’That’s the point. Believe it or not, Jacob Viner thought that the 1933 & 1935 Banking changes were just the beginning of more changes. Deposit Insurance, which FDR opposed and the Chicago Plan economists thought was a good temporary measure, was supported by many banks because they thought it would ease the support for more change. It was a good idea, but fell short of what many people believed was needed.It’s the same deal here. Things will be better for a time, but eventually worsen. I’ve got all my Narrow/Limited/Utility Banking sources ready for the next financial crisis.

Shock and awe the TBTF

Nov 23, 2009 15:39 UTC

For all the fear that bankers have expressed about Representative Paul Kanjorski’s amendment to end “too big to fail,” the final text shows that they don’t have much to fear. While the amendment gives regulators new power, it’s unlikely they’d actually use it.

The Pennsylvania Democrat neuters his own legislation with a single line, which stipulates that for regulators to take action against a systemically dangerous institution (SDI) it must “(pose) a grave threat to the financial stability or economy of the United States.”

But if the point is to break up systemically dangerous institutions pre-emptively, then we want regulators to tear them apart before they pose a grave threat. SDIs tend to fall into that category only after they’re in trouble. By that point it’s too late.

“There’s no political constituency for bank soundness regulation until it’s too late,” says Professor Richard Carnell of Fordham. “Regulators will tend to do what’s politically expedient. During good times that means carrying on business as usual.”

I don’t suspect any regulator today would say that Goldman Sachs poses a grave threat to financial stability. Yet the complexity of its operation and its interconnectedness with the rest of the financial system means that it clearly has the potential to. That may be a fine distinction, but in practice it’s one regulators will be likely to hide behind.

Another problem with Kanjorski’s amendment is that it pollutes bank regulation with politics. The Treasury secretary would have to sign off on resolutions over $10 billion and the president on resolutions over $100 billion.

Walker Todd, a bank expert at the American Institute for Economic Research recently told me: “It’s been my experience over the last 35 years that examiners in the trenches identify the problems in banks quickly. They dutifully pass their concerns up the line, but their criticisms often get wiped away or tamped down for political reasons.”

Examiners do their job well, but politicians get in their way.

I’m torn. At a visceral level, I like the idea of using TBTF status as a hammer to shatter SDIs into pieces. But if this is the best we can hope for, then perhaps it’s better to focus on other structural reforms that will make banks safer and less complex.

Putting OTC derivatives onto exchanges, strengthening capital (the Miller-Moore amendment is a good start), splitting commercial from investment banking, establishing some sort of exposure rules so that SDIs can’t have too much exposure to any single counterparty. But that’s a wish list that will never get done. In the end, I suspect the only way we’ll rebuild a sound financial system is after the one we have blows itself up.


Inertia. You would think that after what has happened with us teetering over the edge (and still just a step or two away from the edge) something significant would be done. Apparently not.

Then again, let a commander-in-chief raise a war cry, as GWB did, and Congress jumps to approve with a blank check.

How strange that national security is a proven winner with military deployment but it seems to pass everyone’s understanding that the financial world and national financing pose equal, if not even more dangerous threats than any armed foe.

Posted by CB | Report as abusive

Sander’s TBTF amendment

Nov 9, 2009 18:07 UTC

Now THIS is legislation to get behind. From Senator Bernie Sanders, Independent from VT.

Update: Reader macstibs posts this link to a petition supporting Sanders.

Be it enacted by the Senate and House of Representatives of the United States of America in Congress assembled,

This Act may be cited as the ‘‘Too Big to Fail, Too Big to Exist Act’’.


Notwithstanding any other provision of law, not later than 90 days after the date of enactment of this Act, the Secretary of the Treasury shall submit to Congress a list of all commercial banks, investment banks, hedge funds, and insurance companies that the Secretary believes are too big to fail (in this Act referred to as the ‘‘Too Big to Fail List’’).

Notwithstanding any other provision of law, beginning 1 year after the date of enactment of this Act, the Secretary of the Treasury shall break up entities included on the Too Big To Fail List, so that their failure would no longer cause a catastrophic effect on the United States or global economy without a taxpayer bailout.

For purposes of this Act, the term ‘‘Too Big to Fail’’ means any entity that has grown so large that its failure would have a catastrophic effect on the stability of either the financial system or the United States economy without substantial Government assistance.

Points for simplicity, though this doesn’t deal with the problem of complexity in financial markets. Still, it’s a good start.

Rob Cox of BreakingViews notes the obvious irony here: Socialist Senator proposes most capitalist bill.

I doubt Kanjorksi’s amendment, when it surfaces, will be quite this blunt. My guess is it will lean more heavily on regulator discretion.


I think this is a MUCH better link to give your readers… (although I like the PDF link to the proposed bill)

Sign the petition -

http://sanders.senate.gov/petition/?uid= c53f1aca-5881-403e-928b-a25980cb4e0c

Posted by macstibs | Report as abusive

Legislation coming to break up big banks?

Nov 5, 2009 14:40 UTC

In a note to clients yesterday, Paul Miller of FBR Capital Markets wrote:

We are hearing that discussion of breaking up large financial institutions that pose systemic risk to the market is gaining traction on the Hill. At this point, discussions are in the early stages, but we understand that an amendment addressing breaking up institutions deemed “too big to fail” could be introduced in the House over the next few days. How does one define “too big to fail” and how would the divestiture process work – these are good questions that Congress will have to address as the discussion moves forward. To our understanding, any amendment that could be introduced in the coming week would likely be vague and would give the regulators discretion to determine which institutions qualify as “too big” and how to address the risk they pose to the system.

[UPDATE: It appears this legislation may be coming from PA's Paul Kanjorski]

Hmmm. A “vague” amendment directing regulators to look into breaking up TBTF banks might not lead to much, not when regulators have made clear they have no interest in breaking up big banks.

[After she gave a speech complaining about TBTF at the Economist's Buttonwood Conference, I asked Sheila Bair if she would favor policies to proactively shrink/break up big banks. She said "no, I don't know how we would do that."]

And breaking up banks is only half the battle. While it’s very important to get commercial banks out of the trading business, if derivative books don’t shrink dramatically systemic risk won’t have gone away.

Neither Bear nor Lehman had a commercial bank. But the size, opacity and interconnectedness of their trading books posed huge risks for the system.

Speaking of the systemic risk posed by derivative books, there’s a very interesting and relevant tidbit in Andrew Ross Sorkin’s new book titled “Too Big to Fail.”

Not long before AIG collapsed, CEO Bob Willumstad went to Tim Geithner — then head of the NY Fed — and asked that AIG be made a “primary dealer,” giving it access to the Fed as its lender of last resort….

He left Geithner with two documents. One was a fact sheet that listed all the attributes of AIG FP [the division run by Joe Cassano that blew the company up] and argued why it should be given status as a primary dealer. The other–a bombshell that Willumstad was confident would draw Geithner’s attention–was a report on AIG’s counterparty exposure around the world, which included “2.7 trillion of notional derivative exposures, with 12,000 individual contracts.” About halfway down the page, in bold, was the detail that Willumstad hoped would strike Geithner as startling: “$1 trillion of exposures concentrated with 12 major financial institutions.”

You will bail me out or I’ll bring the whole system down with me.

Until they neuter the derivatives business by putting all contracts on exchanges, enhanced “resolution authority” will probably be meaningless. Regulators still won’t be able to shutter the largest financials because doing so would cause the systemic event they’re trying to avoid in the first place.


The financial crisis was a result of poor internal operations models that have not been repaired, these operational dysfunctions are more prevelant in larger institutions. There is no need to legislate the break up of large institutions as they will begin to disintigrate on their own whenever the next shoe drops and there is not an extra 4 trillion lying around to support their balance sheets.

Citigroup is looking at writing down 39 billion and Goldman Sachs is taking home a 20 billion dollar bonus year. The market is a Win/Lose Game and when such large institutions are enabled to play the Win/Lose Game with unlimited Federal Funds (which are in fact, not unlimited), then ultimately the pressure on the losers will cause an irreconcilable financial loss to the support mechanism.

They do not need to regulate the size of the institution but regulate the size of the TRADING POSITIONS of any one institution and its related entities.

This will cause a natural divestiture of TBTF’s into smaller enterprizes that can war with each other for trading profits without causing the extreme damage to the countries core that is done lately.

Regulating Proprietary Trading Positions of Commercial Banks is the answer.

This will reduce systemic risk while not reducing service delivery to customers.

Sure, they’ll complain but hey, glad its not my job.

Bubble-wrapping the China shop

Oct 29, 2009 16:58 UTC

Do you think we should establish a government-backed insurance fund for big banks’ risky trading activities? Probably not. But that’s precisely what the administration and Congress agree should be done. Today Sheila Bair proposed her own variation on the theme. At first glance her idea sounds better, but it’s just as bad as the others.

From Alison Vekshin at Bloomberg:

Federal Deposit Insurance Corp. Chairman Sheila Bair, breaking with the Obama administration, said U.S. financial companies should prepay into a fund the government would use to unwind large failed firms.

Congress should set up a Financial Company Resolution Fund and force institutions with more than $10 billion of assets to pay before a firm collapses, Bair said in testimony prepared for a House Financial Services Committee hearing today. Investors in failed companies also should take losses, she said.

As I noted in my column yesterday, Barney Frank’s legislation would have taxpayers front money for systemic bailouts while large financial firms would be on the hook to pay the money back.

Of course that would never happen. Banks would never pay. Look how hard it’s been to get banks to replenish the Deposit Insurance Fund. Anyway, Sheila agrees that ex-post funding is a bad idea.

But pre-funding is an equally terrible idea. If there’s a fund somewhere that’s supposed to protect the system, that will codify TBTF and reinforce moral hazard. Not only will investors know some firms are TBTF, they’ll see there’s a pile of cash to protect them. This would put TBTF firms at an advantage in the marketplace.

Now, some would argue that it would penalize the firms because they’d have to pay capital into the fund. Perhaps in the short-term. But soon enough everyone will be content that the system is “safe,” people will be making money and Congress will tell the regulators to lay off.

This is not just a hypothetical. Look at our experience with the Deposit Insurance Fund. From 1996-2006, FDIC was prevented by statute from collecting insurance premiums. Congress, in its infinite wisdom, had determined the DIF didn’t need any more money because the system was firing on all cylinders.

The S&L crisis–which cost $150 billion to resolve–taught us the moral hazards of government insurance funds for bank creditors. Because their money iss guaranteed, depositors don’t care what kind of risky activities their bank are engaged in. They just go to the bank that offers the highest interest rate.

We’re reminded of this fact by GMAC today, whose subsidiary Ally Bank is able to attract billions in deposits by offering high interest rates. And read the Puget Sound Biz Journal’s article on WaMu. They were so desperate for funding amid a bank run last fall that they started offering 1-yr CDs at 5%.

And think about what’s being insured here. Trading. In derivatives, stocks, bonds, forex, commodities …. all of it with leverage. Trading + leverage = high risk!

Despite the moral hazards of deposit insurance, we insure commercial banks because the functions they provide (managing the payment system, turning savings into loans) are important to society. In the fullness of time, I have my doubts that even this makes sense. But arguments supporting it are at least defensible.

This new scheme that Bair is proposing would insure investment banks, and all the risky trading activities they engage in.

Again, we’re acting to protect the needs of TBTF banks rather than protecting the needs of society. What we should be doing is getting trading activities out of the banks to begin with.

The repeal of Glass Steagall essentially put the Wall Street Bull inside the China Shop we call the commercial banking system. We’re surprised when he trashes the place every few years?

But instead of kicking him to the curb, we’re expending all this effort putting the China in bubble wrap…..which in the long-run is no match for the Bull….


The Republic of China in bubble wrap…which in the long-run is no match for the Dollar…

Posted by Casper | Report as abusive

Break up the big banks

Sep 15, 2009 17:07 UTC

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.


Semantics. It’s C R I M I N A L! There, one word, one meaning. Educate yourselves about the central banks history and the Bank of International Settlements and find out who, what, when and why.

Only until the global community wakes up from the fog of prevarication can we return to asset based economies and abundance for the masses.

Posted by Epiphany Hoskins | Report as abusive

Bair on ending “too-big-to-fail”

Jul 23, 2009 16:02 UTC

FDIC Chairwoman Sheila Bair is right now testifying in front of the Senate Banking Committee on “establishing a framework for systemic risk regulation.”  This is of course hugely important.  How do we end “too-big-to-fail?”  And how do we resolve failures that are so big they pose a systemic risk?

There’s so much valuable stuff in this testimony, readers should really see all of it.  To help you get through all 30 pages, I’ve highlighted key passages and provided commentary (in pink italics…I didn’t choose pink, btw, Scribd just read my formatting that way!).

Bair clearly knows what’s wrong with the system, and she articulates it more clearly than any other policymaker in Washington.  She really does want to put the screws to big banks in order to end too-big-to-fail.  She would do so by establishing a Financial Services Oversight Council to, among other things “actively control” leverage. She would also beef up resolution authority so policymakers could wind down bloated behemoths like Citi.

Right now they can’t resolve anything.  Regulators’ choice is between bankruptcy and taxpayer-funded life support.  Bankruptcies don’t work with systemically important institutions.  This we learned from Lehman.  Taxpayer subsidies only allow failed companies to keep operating on the public dime.  Neither is desirable.

My chief worry in what she’s proposing is that whoever ends up becoming the systemic risk regulator may not have the same cojones she does.  Who’s to say they will actually put the screws to the firms being regulated?

If they don’t, its sheer presence may backfire, especially if–as she proposes–there’s an “insurance fund” backing its resolution authority.  Private market players will then misinterpret the systemic risk regulator as an implicit government guarantee that protects them from risk.  Exhibit A is OFHEO with Fannie and Freddie.  Exhibit B is FDIC itself and its Deposit Insurance Fund.  Investors and/or depositors in these federally-backed institutions take MORE risk that creates BIGGER systemic problems than if there was a credible possibility they’d eat their own losses.

All of this would be much easier if the Fed just exercised its authority over bank reserve requirements.  Requiring banks to hold significantly more capital in reserve, and preventing them from hiding risk off their balance sheets, would solve just about every problem we face.

(For ease of reading, click on the top right button to toggle to full screen.  If that doesn’t work, click on the link at the top to go directly to Scribd.)

Sheila Bair Systemic Rist Testimony 072309


As you say, “My chief worry in what she’s proposing is that whoever ends up becoming the systemic risk regulator may not have the same cojones she does”

When things get risky, it also means somebody, many, are making out like a bandit. These folks will be raking in the bucks, be willing to spread some around politically and will be busily networking with the rich and powerful in DC. The question posed for the regulator is whether to cut short the banditry with the associated disruption while not knowing when it would otherwise self-destruct if no action is taken, the old punch bowl that never seems to have been taken away. Greenspan was a god, remember?

So any pressure to act is offset by the uncertainty about what bad stuff will come and when. How often have we heard about there being no way to tell if you are in a bubble? More accurate is to say how to predict when the bubble will end is impossible. Bureaucracies, regulatory or otherwise, love to keep on keeping on with the status quo. How many times this behavior has been seen yet we keep coming up with the same inadequate scheme.

What really does the trick is very, very bad pain…the kind of 1930′s pain that alters the mindset of a generation. That is the most effective regulator because it is a policeman that sits in the minds of millions, often for the rest of their lives as it did with my parents.

Which is better for people to think:

“Jesus, that period of my life was hell. Never again will I touch (fill in the blank).”


“Hey, someone is watching over it all, let’s roll”

Posted by CB | Report as abusive