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Editor At Large

Carving Up Big Banks Won't Work, Any Way You Slice It

Banks that are too big to fail are too big and should be broken up.

It's a simple, even comforting, solution to the risks posed by megabanks.

But it will never happen — and that's OK.

Barbara A. Rehm

Why? Because federal regulators have a workbench full of tools to tame the largest banks and the government wants to test them before it plows into the private sector with such an intrusive, irreversible step.

Critics claim the bailouts of 2008 undermined capitalism, and they are right. But arbitrarily breaking up the largest financial companies would strike a much bigger blow to our economic philosophy.

And it strikes me as strange that no one waving the "break 'em up" banner has answered fundamental questions like how big is too big or what's the best way to cut an institution down to size. Is it a strict asset cap, or some sort of concentration trigger? Should we carve banks up by business line, or perhaps by geography?

We've only had ultralarge financial companies for five years, and most of them bulked up by absorbing a weaker competitor during the crisis. Since passage of the Dodd-Frank Act in mid-2010, most of these banks have gotten smaller, bowing to both market forces and regulatory nudging.

Breaking up the big banks sounds a whole lot better in theory than in practice.

Imagine the circles policymakers would have to square.

Would you break up Bank of America but not Wells Fargo? Both are huge. Both provide valuable products and services to millions of customers. But Wells is more profitable and has a better management track record, so should the government let it stand while it carves up B of A? Or should they both be broken up? How would you feel about that if you were a Wells Fargo employee, shareholder or customer?

What about Goldman Sachs? It's the "great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money," right? So let's break it up and feel good about ourselves.

But where would that approach end? Who should decide which companies are worthy and which deserve death by government fiat? Do we really want the government making such calls? And if not, are you willing to see great companies dismantled because a similarly sized competitor isn't as strong or respected?

Wouldn't that take the politicization of financial services to new and scary heights? And don't forget we already have size limits on banks. Since 1994 federal law has prohibited any single bank from growing through acquisition once controls 10% of the nation's deposits. Dodd-Frank added a 10% asset cap.

But just months before the reform law was enacted, the Senate debated and rejected on a 61-to-33 vote a provision to crack down further on bank size. The Brown-Kaufman amendment would have restricted a banking company's nondeposit liabilities to 2% of the country's GDP (roughly $300 billion at that time) and prevented banks from leveraging their capital more than six times.

The Obama administration, led by Treasury Secretary Tim Geithner, has consistently rejected calls to break up the biggest banks, and the only sitting federal regulator who publicly supports the idea is Tom Hoenig, the former Kansas City Fed president who just joined the FDIC board.

Probably the most fervent advocates are former FDIC Chairman Sheila Bair, Independent Community Bankers of America President Cam Fine and Simon Johnson, the IMF official turned MIT professor who frequently writes and speaks on the topic.

Dallas Fed president Dick Fisher recently reignited the debate.

"I believe that too-big-to-fail banks are too-dangerous-to-permit," Fisher wrote in the Dallas Fed's annual report released last month. "I favor an international accord that would break up these institutions into more manageable size."

But beyond Fisher's vague "international accord," he has not explained how he would go about dismantling the largest banks.

His director of research, Harvey Rosenblum, penned a detailed piece for the annual report that has gotten a ton of attention.

In his essay, Rosenblum acknowledges that Dodd-Frank is likely to reduce risk in the financial system and lead some institutions to shrink. Market discipline is already eroding the big banks' cost-of-funds advantage, he notes, and credit rating agencies have lowered their scores for some large banks.

Still Rosenblum doesn't trust policymakers to pull the plug on a large financial institution. "Words on paper only go so far," he writes. "The pretense of toughness on TBTF sounds the right note," but it doesn't give policymakers "the foresight and the backbone to end TBTF by closing and liquidating a large financial institution."

Rosenblum can't know this — nor can anyone else. What we do know is that Dodd-Frank gave federal regulators numerous and wide-ranging powers to tame too big to fail institutions.

The reform law gave regulators the right to take over and liquidate any systemically important company, impose losses on shareholders and creditors and fire management.


(10) Comments



Comments (10)
we will not benefit.
Posted by srevilla | Wednesday, July 25 2012 at 4:28PM ET
I believe this real problem is how the regulators can prevent over control with the paranoia of preventing future crises and balancing that out with anticipating the consequences of any controls they put in place. They will need to manage the risk of their own actions. I am not familiar with the details of all the regulations however I am not aware how much thought and modeling goes behind a regulation. Until they can pull together some strong predictive models and scenario testings, and churn out protective regulations rather than ones that will implode the banking industry.
Posted by srevilla | Wednesday, July 25 2012 at 4:25PM ET
Barb & Tom -- Deeply disturbing to think that we can agree on need to break up the Too-Big-To-Fail banks, but you are quick to shoot down the easiest, fastest solution available, and offer no other option. Doing nothing strikes me as a totally unacceptable position. Glass-Steagall worked for 66 years to keep big banks from giving in to the high-risk behaviors that caused both the Crash of 1929 and the Financial Crisis of 2008. The law would force an immediate down-sizing of TBTF institutions. Perhaps more importantly, it would put the onus for figuring out how to down-size on the institutions themselves, not on federal financial regulators who apparently lack both the skill and the will to do this for them.

A compromise could give TBTF banks the option of maintaining their current high-risk structures. But, they would have to forfeit their FDIC insurance. President Roosevelt understood that if the government was going to insure bank deposits, those banks could not continue to act like casinos.
Posted by jim_wells | Friday, April 27 2012 at 8:29AM ET
It's not that breaking up banks makes us feel good about ourselves, it's that it takes the pointed gun from the taxpayers heads. Commercial Banks should be no bigger than 3% of GDP, Investment Banks no bigger than 2% of GDP.
Posted by TxTim | Thursday, April 26 2012 at 3:58PM ET
They got TBTF in the first place because regulators and policymakers encouraged them to. It is probably to late to undo the damage and too much to expect that regulators and professors will prevent systemic risk. More capital and unambiguous enforcement is the only answer.
Posted by kvillani | Thursday, April 26 2012 at 3:29PM ET
I agree Tom. It's interesting how many people point to the repeal of Glass-Steagall as this big turning point. While I do think it helped to change the culture of commercial banking, loosening it up with more investment bankers, I don't think Gramm-Leach-Bliley is responsible for the financial crisis.
Barb Rehm, editor at large, American Banker
Posted by brehm | Thursday, April 26 2012 at 3:25PM ET
Barb, I compliment you on outlining some key issues. I want to point out to the commentators that the ending of Glass-Stegall allowed the banking system to survive. The integrated banks with one exception only needed liquidity when their was panic throughout the economy. The banks that created that panic were not banks that took advantage of Glass-Stegall. Countrywide, Washington Mutual were old fashioned mortgage banks. Bear Stearns, Lehman Brothers and Merrill Lynch were old fashioned investment banks. Citibank got into trouble the same way all the commercial banks got into trouble in the 1980's; holding too much correlated credit risk. AIG wasn't even a bank, and they got into trouble the exact same way. Reinstating Glass-Stegall is not going to prevent a similar crisis, it would only increase the probability the one might occur. More effective regulation is the only solution and yes, we are then relying on the regulators to do a good job and there is risk in that.
Posted by Tom White | Thursday, April 26 2012 at 3:19PM ET
Whether Dodd/Frank will fail or succeed or even remain is yet to be seen but will prove interesting at least.
What we really need to consider is , had or do regulatory agencies actually do their job, and what were they looking at over the past 9 years, and finally are all "pigs equal" or are some just more equal than others"???? In a pure capitalist system an institution as moronic and corrupt as some of those who were bailed out would be swiftly punished by the market.
It is not a matter of picking or chosing, but rather implementing policy specific to financial institutions, that would limit maximum size and giving a 5 year period for those already above same to spin off and restructure.
Posted by tfer | Thursday, April 26 2012 at 2:14PM ET
Frankly, who cares if breaking up TBTF banks is a blow to our economic philosophy when letting them continue threatens a death blow to our economic survival? Frankly, there would be less of a problem with big banks if Glass-Stegall was fully restored, if effective controls were in place to curb modern abuses posed by casino banking, and if big banks had less political sway to capture the regulators. But Dodd-Frank provided little to none of this. So in its absence, break the big banks up. Then lets return those smaller and less politically powerful entitites back to the safe, sound and boring banking of yesteryear.
Posted by j.doe | Thursday, April 26 2012 at 10:03AM ET
Having suffered through the worst economic disaster in the U.S. since the Great Depression, why is it so difficult for policy-makers to see that the first step in returning the nation's financial system to a sound footing is restoring the law enacted at the end the previous crisis? The law that successfully protected the country from a similar debacle for 66 years? The Banking Act of 1933 created the FDIC to restore faith in deposits at commercial banks AND Glass-Stegall which forced banks to stop acting like casinos. Hard to see how the country would not benefit from returning to a regulatory policy that proved itself over time.
Posted by jim_wells | Thursday, April 26 2012 at 9:35AM ET
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