While the backlash from Wall Street against stricter capital standards to reel in the "too big to fail" problem has begun, community banks are on board with a plan to address the issue once and for all. The Terminating Bailouts for Taxpayer Fairness Act, introduced by Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., would implement higher capital levels to address one of the most egregious distortions of our free market system—the government guarantee against failure of our largest financial firms.
The fact that Congress is eyeballing the megabanks' capital should come as no surprise to Wall Street or anyone else. We all have vivid memories of those panicked days of 2008 and 2009, when the stock market crashed, unemployment began its rapid climb to double digits and interest rates dropped to nearly zero. Those days were reminiscent of the Great Depression in which the masters of the financial universe teetered on the brink of disaster because they didn't have the cash to pay their rapidly accumulating debts. Secret weekend meetings were held inside the great halls of the Treasury Department, Federal Reserve and U.S. Capitol to determine how policymakers could assure that we would still have an economy on Monday. To keep the financial system from complete collapse, taxpayers were left to bail out the money lenders.
While regulators now have greater authority to shut down these institutions, which are now required to have their living wills in place, these regimes are inherently reactive in that they provide guidance on what to do after the next disaster strikes. Meanwhile, the "too big to fail" problem is bigger than ever, with the 10 largest banks now holding assets equal to 71% of the gross domestic product, up from 58% in 2006.
To protect against future calamities, the Brown-Vitter bill would set capital standards that vary depending on the size and complexity of the financial institution. The bigger the bank, the greater its risk to the financial system, and the higher its capital rate would be. This would reduce the likelihood that megabanks would reach the brink of failing and that the financial system would go bust. Community banks under $50 billion in assets already have strong capital ratios that are appropriate to their business model and are therefore exempted from higher capital requirements.
The other half of the bill—which would provide targeted regulatory relief to community banks—is equally important to our nation's financial and economic well-being. While the megabanks have enjoyed their "too big to fail" protections against downside risk and Justice Department prosecution, the oft-forgotten sector of the banking industry has paid the price.
The high-risk behavior of our largest financial institutions typically leads to stricter government regulation across the banking industry. And while the megabanks can afford teams of lawyers to deal with the flow of red tape, smaller institutions struggle to keep up. Too often, when Wall Street sneezes, Main Street catches pneumonia . Sometimes it's fatal.
This phenomenon of megabank behavior resulting in more regulation is not new, and some have even suggested that it is just another questionable megabank business practice. After all, Wall Street executives and their lobbyists don't want higher capital ratios, because a safer bank results in less leverage, lower return on equity and, yes, lower bonus payouts.
But it is nonetheless destructive to local economies as community banks are forced to direct their resources toward regulatory mandates instead of small-business growth and community development. While policymakers have made progress in distinguishing Main Street community banks from Wall Street megabanks, we are still a long way from truly tiered regulations. The common-sense steps taken in the Brown-Vitter bill, from expanding qualified mortgage protections to eliminating annual privacy notice redundancies, are a good start.
Employing stricter capital guidelines on the largest and riskiest financial firms while easing the regulatory burdens they have caused for the rest of us would work together to remove excessive government distortions in our nation's financial sector. Despite the inevitable kicking and screaming from Wall Street, these reforms are essential to freeing up our markets and putting the "capital" back in capitalism.
John H. Buhrmaster is president of 1st National Bank of Scotia in Scotia, N.Y., and chairman-elect of the Independent Community Bankers of America.