House Bill Would Force Big Banks to Compete in Free Market

It's been a bleak winter for financial reformers in the United States. Legislators have introduced, and in some cases passed, a number of bills that aim to gut various components of the Dodd-Frank Act. But one Congressman recently introduced a bill that makes reform prospects for the spring look a whole lot better.

Last week, Rep. Michael Capuano introduced The Subsidy Reserve Act of 2015, also known as H.R. 888. The bill should be welcomed by those of us who are tired of seeing our taxes diverted from critical investments in education, infrastructure, and healthcare in order to bail out or subsidize big banks.

The bill will require U.S. banks with over $500 billion in assets to calculate and accumulate capital equal to the amount of the market subsidy they receive from taxpayers. The Federal Reserve Board, Financial Stability Oversight Council and the Office of Financial Research would "establish a formula for determining the financial benefit" received by a large bank "as a result of the expectations of shareholders, creditors, and counterparties" that it would be rescued by the government in the event of failure.

This market perception of a government safety net, as seen in bond yields and credit spreads, is extremely important. It enables large banks to obtain cheaper funding and receive financial benefits such as cheaper pricing and more favorable collateral terms when they trade derivatives. Smaller banks and nonbanks do not receive these valuable financial benefits.

One advantage of the bill is that it would address a key imbalance between large and smaller banks. Smaller banks are currently engaged in a battle of attrition with too big to fail banks, as documented in a recent study by Harvard University's Kennedy School of Government.

The main purpose of the bill, however, is to insure that large, complex, and internationally interconnected banks can survive unexpected losses without causing contagion to the global financial system. If bank regulators found that a particular large bank was not receiving a subsidy, it would be exempt from this requirement.

Cornelius Hurley, a professor of banking law at Boston University and the mastermind behind H.R. 888, told me that it is important that "the subsidy buffer is not based on flexible risk-weighted assets" as is the case with the international bank regulatory capital framework, Basel III. "Market perception of a subsidy would drive this capital buffer," Hurley said.

Capuano, a Democrat from Massachusetts, filed similar legislation back in 2013 as H.R. 2266. As Capuano explained to me, he has now reintroduced the bill because "this is a new Congress." He acknowledges that he might not have an easy time navigating the political maze without "the bill possibly becoming a hot potato between those who want to dismantle Dodd-Frank and those who do not want Dodd-Frank changed at all."

Capuano plans to spend a lot of time "explaining the complex issue of how big banks are awarded a competitive advantage" due to the expectation of government support. This should be "considered un-American," Capuano said.

In my opinion, the bill should garner strong support not only from financial reformers, but also from the 6,500 community banks in the U.S. The bill would get to the heart of determining whether the U.S. is truly a market economy.

Camden Fine, president of the Independent Community Bankers of America, told me that "H.R. 888 is an elegant solution to a very nasty problem in financial services." Even the smooth, mellifluous tones of his native Missouri accent cannot hide his passion for the bill. "If we really are going to have a free market system, we cannot have a government-protected class of banks," he said.

Before heading the ICBA, a professional trade association, Fine was a community banker in Jefferson City for 25 years. He has seen community banks fail throughout his career.

"All of them were subject to market forces, good or bad," he said. When community banks fail, "the government does not bail them out. Unlike what happens with big banks, shareholders get wiped out, and in fact, the failed bank's directors can face civil suits.'

Like Fine, I find it intolerable that "only community banks are required to compete in free markets."

The next step should be to get bipartisan support to insure the bill's passage. Rep. Capuano has been "actively looking for a Republican co-sponsor," and acknowledged that this "could be optimistic."

However, there is precedent for bipartisan support in the field of financial regulation. Senators Sherrod Brown and David Vitter reached across the aisle to introduce a bill to regulate large banks, as did senators Elizabeth Warren and John McCain.

I believe that H.R.888 could change the bank regulatory landscape significantly. I agree with Hurley that "there is no reason that a Senator Warren, a Senator Rand Paul or Congressman X could not support this bill."

Politicians on both sides of the aisle keep saying that they are worried about too big to fail. Taxpayers should demand that they turn their sound bites into action.

Most of us lack the deep pockets of big-bank lobbies, but there is nothing to stop us from reaching out to our legislators. After all, as Fine says, quoting the legendary House Speaker Tip O'Neill: "All politics is local."

Mayra Rodríguez Valladares is managing principal at MRV Associates, a New York-based capital markets and financial regulatory consulting and training firm. Follow her on Twitter at @MRVAssociates.