Despite the best efforts of a divided Congress, the world knows that the malignancy of too-big-to-fail endures to this day. An ever growing roster of public officials, industry participants and academics has voiced its opprobrium of TBTF banks as equal-opportunity abusers.
TBTFs abuse taxpayers with their stealth subsidy. They abuse their customers and competitors with skewed pricing. And, worst of all, they abuse the financial system by exposing it to yet another series of bailouts.
It seems that departing Treasury Secretary Timothy Geithner, former Rep. Barney Frank, and the leaders of the TBTFs themselves, are the remaining holdouts endorsing the notion that, in finance, bigger and more complex is better. We are fortunate, however, that broad and bipartisan support has emerged to address this persistent problem. Evidence of this can be found in the demand of a unanimous Senate, spurred to action by Sens. Sherrod Brown and David Vitter (politically, as odd a couple as can be imagined), that the Government Accountability Office measure the taxpayer subsidy afforded the TBTFs.
Last week, former FDIC chairman William Isaac and I laid out a new approach for solving the TBTF problem. While fair, transparent and simple, it relies on market discipline, not heavy-handed government intervention for its execution. It will result in smaller, more vibrant, and more competitive firms – firms that contribute to the economy rather than abuse it. It's called the Subsidy Reserve Plan.
In sum, the plan would require each TBTF to establish a "subsidy reserve" line item on its balance sheet and add to it each year the estimated subsidy it receives from taxpayers in the form of reduced funding costs. The estimate would come from the GAO study supplemented by work of the new Office of Financial Research.
The reserve would not substitute for the bank's regulatory capital but would be available to protect creditors and the Federal Deposit Insurance Corp. in the event of failure.
The reserve would accrue year after year and could be distributed to shareholders only in proportion to a bank's shrinkage via asset sales, divestitures or spin-offs. A proportionate share of the reserve would be allocated to such sales and divestitures. It could not be used for dividends, share buybacks or bonuses. If the bank shrank to a size such that it was no longer perceived as too big to fail, the subsidy reserve requirement would end and the remaining balance in the subsidy reserve account would be combined with unrestricted capital .
Absent such sales and divestitures, the reserve would accumulate over time such that it would be shareholders – not regulators or politicians – that would demand the shrinking of the bank. This is market discipline in its purest form.
Here is the actual legislative language to implement the Plan—all 293 words of it:
SECTION 1. Section 165 of the Dodd-Frank Wall Street Reform and Consumer Protection Act is amended by adding after subsection k:
"(l) The Subsidy Reserve
(1) The Board of Governors shall require each nonbank financial company supervised by the Board of Governors and each bank holding company with total consolidated assets equal to or greater than $500,000,000,000 to establish and maintain a capital account called the "Subsidy Reserve.
(2) In consultation with the Financial Stability Oversight Council and the Office of Financial Research, the Board of Governors shall, after notice and opportunity for hearing, establish a formula for determining the financial benefit received by such firms as a result of the expectations on the part of shareholders, creditors, and counterparties of such firms that the Government will shield them from losses in the event of failure.
Without the subsidy of deposit insurance, banks will restructure themselves into healthier, less risky economic entities. Safety and soundness will become a basis of competition, as will risk/reward. Shareholders and executives will bear their fair share of the risk. Some banks will remain very large specialists in transactional banking. Others will become specialized lending companies with deep expertise in their fields. Still others will become investment managers with a range of debt, equity and other funds. We will end up with a much stronger system that does a better job of satisfying its customers. Markets not subject to the distortion of politicized, government mandates are always more efficient.
Since, in the US and most developed countries, virtually all individual depositors are covered by government guarantees, why does CSSB say that banks are presently the depositors' problem?
Is it not possible that the industry's high leverage is due to the fact that deposits are insured, and that without such insurance the market would demand either lower leverage or less risky portfolios, and more transparent disclosure than the government regulators require today?
As to whether banks can never be shareholders' problem, I wonder if the former shareholders of Lehman Brothers or Bear Stearns would agree.
On July 9, 2008, Robert Steel became president and CEO of Wachovia after working for Goldman Sachs from 1976 to 2004 and the US Treasury under former Goldman Sachs CEO Henry Paulson from October 10, 2006 until July 9, 2008. Mr. Steel was "the principal adviser to the secretary on matters of domestic finance and led the department's activities regarding the U.S. financial system, fiscal policy and operations, governmental assets and liabilities, and related economic matters," according to Wikipedia's biography. Mr. Steel most likely knew about other firm's borrowings via his time spent at the U.S. Treasury Department.
On July 22, 2008, Mr. Steel personally purchased 1,000,000 shares of Wachovia's stock as the company's undisclosed Federal Reserve Term Auction Facility (TAF) borrowing reached $12.5 billion, which appears not to have been disclosed in securities filings audited by KPMG.
In an interview with CNBC's Jim Cramer On Monday, September 15, 2008, Robert Steel said "I think it's really about...transparency. People have to understand the assets and really be able to say, this is what I own... Complete disclosure. ...we can work through this with transparency, liquidity and capital. ...Our strategy was to give you all the data so you could make your own model. We tell you what we're doing... ...we're raising capital ourselves by basically shrinking the balance sheet, cutting the dividend, cutting expenses. We can create more capital ourselves that way... for now, we feel like we can work through this..." After Jim Cramer asked "Should there be any sort of quick regulatory relief from the SEC that would make life easier to be able to make your bank much stronger?", Mr. Steel responded "I don't think it's about my bank."
After not reporting TAF loans, Wachovia's CEO wrote "I, Robert K. Steel, certify that: I have reviewed this Quarterly Report on Form 10-Q for the quarter ended September 30, 2008 of Wachovia Corporation; Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report" on October 30, 2008.
Mr. Steel was at least aware of Wachovia's Federal Reserve loans since July, 2012, if not the undisclosed loans to multiples of other financial institutions.
If Mr. Steel was "the principal adviser...on matters of domestic finance and led the department's activities regarding the U.S. financial system, fiscal policy and operations", how could he not have known and acted on undisclosed material information?
On June 22, 2010, Robert Steel was appointed Deputy Mayor for Economic Development by New York City Mayor Michael Bloomberg, after which, Steel resigned his seat on the Wells Fargo board. According to Morningstar data, Mr. Steel owned 601,903 shares of Wells Fargo in 2010, which would be worth $20,446,644.91 as of October 26, 2012.
George Hartzman
Greensboro, North Carolina