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The Absurdity of Too Big to Fail Banking

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In this very political season, lobbyists for the too-big-to-fail banks are quietly holding briefings for congressional staffers, Obama administration members and hopeful Romney campaign economic advisors. The lobbyists are arguing that the rise of TBTF banks and the 1999 repeal of Glass-Steagall were actually good for the country. 

The points these TBTF'ers make are threefold.  First, large U.S. companies need world-class banks because, if banking size in the U.S. is limited, American companies will replace their U.S. banks with larger European, Japanese or Chinese banks. 

Second, the lobbyists claim, the consolidation of commercial and investment banking had nothing to do with the financial crisis.  The Glass-Steagall repeal is merely a scapegoat. That outdated law would not have restrained Bear Stearns, Lehman, AIG, Washington Mutual or Ally – all of which played a role in the panic. 

Lastly, the megabank representatives cry that all the chatter about TBTF ignores the tremendous “social utility” of the large banks to add value and to be a source of strength to bail out other institutions during times of crisis.  

It is a testament to the TBTF lobbyists' prowess that they are taken seriously in urging our policymakers that we emulate European banks. Woefully undercapitalized, those banks are a leading challenge to the Euro itself.  Does anyone really need to be reminded of the nationalization of the certain British banks, the entire Irish Banking system, the German state banks and the Spanish provincial banks, to name only a few recent era headlines?  The French and Italian banks are also under intense market scrutiny.  The ultimate irony is that the European-U.S. dollar funding crisis would be far worse if not for support from the U.S. money market funds and the Federal Reserve via the European Central Bank. 

Now, the TBTF'ers argue that the next place our big corporations would flee is the Japanese banks.  Do we really want to emulate a banking system that has been the primary cause of two decades of lost economic growth? 

Finally, perhaps the most laughable example given from what should be a group of uber-capitalists is that the Chinese banking system should serve as a model for us. I suspect that most U.S. corporations would stick with their American banks over those controlled by the largest Communist party in the world.

The Glass-Steagall repeal was not the sole cause of the financial crisis but certainly a contributor.  There is no doubt that Citigroup and Bank of America needed their extraordinary added TARP funds and FDIC guarantees, judging from their exposure to investment banking activities.  A fair read of the contemporaneous concerns regarding Citi and Bank of America would lead to no other conclusion.  In the case of Bank of America, the worries about the bank's own legacy mortgage holdings – and those of Countrywide – came months later. 

But there is a deeper concern as well.  It was not merely the technical repeal of Glass-Steagall that was a contributor to the crisis, but rather the permission regulators gave to the banks for the “cultural consolidation” of commercial and investment banking.  Even before Glass Steagall was repealed, the Fed permitted banks to engage in investment banking (up to certain limits), finding that these activities were “incidental” to commercial banking. Frankly, these activities are not necessary to run a successful bank or even a successful large bank.  U.S. Bank is one example of a large bank that has done well with hardly any underwriting or trading operations (most of what it does in this area is wealth management or stock brokerage).

Lastly, the TBTF'ers argue that the big banks create value for the economy, which is of course true.  The question is whether a better structured banking system would create far more value and additional jobs through effective financial lubrication of the economy.  Small and medium-sized banks are more effective at making loans to the small and medium-sized companies, which are the primary job creators in the U.S.  Large banks need to homogenize their approach to smaller companies, which is understandable and more efficient for big banks.  But what is good for the big banks is not necessarily good for the economy and the growth of jobs.

If policymakers can get the structure of the banking system right, there will be less of a need for the volumes of devilishly complex regulations, which are being created almost weekly, as I recently described at the TEDx Wall Street conference

Once the election is decided and Congress gets back to work, fixing the banking system and reinstating Glass Steagall should be the highest priority.

Scott A. Shay is a founder and the chairman of Signature Bank in New York.

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Comments (5)
It is impossible to regulate and examine a community bank using the same standards applied to Citi, J. P. Morgan Chase and the other "Too Big to Fail" banks. Reinstating Glass Steagall would be a great step to reducing the risk for the FDIC fund established to protect depositors and not to insure risk taking that the big banks are famous for doing.
Surely someone else can see the risks involved in the current system.
Posted by Moneychanger | Thursday, September 20 2012 at 2:36PM ET
Scott Shay has the nail smack on the head in full force. I would add that the regulatory system is stacked against smaller than too-big-to-fail banks because they do not have the Treasury-Fed guarantee. This makes them appear riskier to the examiner becasue they must be self sufficient which leads to demands for more capital and an increased aversion to take risks that are not sanctioned by the examiners.
Posted by Gerald Hanweck | Thursday, September 20 2012 at 5:05PM ET
So where is the "Social Utility" in concealing, stealing, and robbing homes and money from homeowners. Too big to fail, but not too fat to jail. I, for one, am filing criminal charges for those mortgage servicer employees who intentionally concealed information (double posting $32k Capitalized Interest Arrears), and intentionally lied about it. Professional insurance will not help them. Maybe I will end up with their home and job.

The last words from my Green Tree Servicing, LLC single point-of-contact earlier this week still rings in my ears that "Your home is in foreclosure, and I am going to laugh when you loose it.' ok. He lost commission because I refused to modify a loan that was illegally foreclosed on by GMAC not honoring a Forebearance Agreement the first day they took over servicing and piling on the fees. Through my complaints I hope he looses his job.

"Independent Foreclosure Review" OCC boasts when there is absolutely nothing independent about that effort. What a Joke on the American People. OCC assisted and continues to assist the mortgage servicers in this evil effort by aiding in the cover-up. OCC was busted on hiring a friend's company for the review which was really meant to do absolutely nothing. Found 100% of Wells Fargo loans to be in compliance. Who does OCC think really believes that bull?

I am embarrassed to say, as a CPA and CGFM who specializes in financial systems, I worked there for 5 years. Glad I left years ago! My professional ego could not have tolerated working there in today's environment. It literally has made me sick!
Posted by sjnewport | Thursday, September 20 2012 at 7:49PM ET
Scott is correct. I wish more policy makers would understand the points Scott makes and the points Tom Hoenig makes. Hopefully after the elections we can get down to actually doing something about how the TBTF algae needs to be cleared out of the financial services pond before it takes it completely over and destroys all other eco systems.
Posted by commobanker | Sunday, September 23 2012 at 2:41PM ET
Scott Shay is correct. The simple act seems to get allot of no responses why! Could it be because the separation and requirements demand responsible banking... maybe boring but effective in meeting the commercial needs of America.
Posted by jophoenix | Saturday, March 30 2013 at 8:04PM ET
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