There is no simple solution to "too big to fail," a complicated problem born of a series of policy missteps that will take years to unwind.
The sooner everyone involved in this debate accepts that reality, the sooner we can start answering the tough questions necessary to make sound public policy.
Instead, we seem stuck in the bluster and finger-pointing stage.
A case in point: Simon Johnson's piece on The New York Times' Economix blog last week. The MIT professor declared the "too big to fail" debate over and credited the mess in Cyprus for this miraculous consensus.
"The decision to cap the size of the largest banks has been made," Johnson wrote. "All that remains is to work out the details."
I missed that "decision," and of course, those "details" are exactly what's being debated.
Johnson and other large-bank critics are ecstatic that Federal Reserve Board Chairman Ben Bernanke agreed with Sen. Elizabeth Warren, D-Mass., that "too big to fail" must end.
But Bernanke also said that the Dodd-Frank Act of 2010 includes myriad tools for tackling the issue, and that these tools ought to be given time to work.
"There's a three-part plan under Dodd-Frank," Bernanke testified before the Senate Banking Committee in February. "Part No. 1 is to impose costs on large institutions that offset the benefits they get in the funding markets — for example, capital surcharges, activity restrictions, liquidity requirements, living wills, a whole bunch of other things that impose greater cost and force the largest firms to take into account their systemic footprint."
"That's No. 1," Bernanke continued. "No. 2 is the orderly liquidation authority, which we're working closely with the FDIC and with our foreign counterparts to figure out how we would take down a large institution without bringing down the system. And part three is a whole raft of measures to try to strengthen the overall financial system so it will be more credible that we can take down a large institution without bringing down the system. That's sort of the three-part plan. And it's working."
We can debate whether "it" is indeed working or perhaps even more important, whether it will work.
It's impossible to predict the future but Dodd-Frank did take away regulatory discretion, in both directions. It bars bailouts and forces regulators to resolve troubled banks. It mandates a resolution regime that wipes out shareholders, kicks out management and imposes losses on long-term creditors.
It requires every systemically important financial institution to submit and continually update living wills that lay out for regulators a resolution road map. These companies face higher and stricter capital and liquidity standards as well as limits on leverage and counterparty risk. They are subject to repeated stress tests to gauge how well they would withstand economic shocks.
Obviously, for any of this to work the regulators must translate the law into tough, sensible rules, and then they must enforce them fairly and consistently. Examiners have to stay on top of these systemically important companies and demand changes when they see weaknesses.
It's fair to question how well the agencies are doing so far. I did so last week.
But I do believe the regulators are willing — and will soon be able — to shut down a large company that gets into trouble. They want to comply with the law; they've seen the destructive impact of bailouts.
Most regulators will tell you privately (and some, like Richmond Fed President Jeff Lacker, will say it on the record) that they learned a hard lesson with Bear Stearns in March 2008.
Bear Stearns' rescue was the first in a series that created our current reality — huge, concentrated companies that a lot of people fear are too big to be managed or supervised or even to be held accountable to our laws.
That's not good for our country, our economy or the banking industry.
So let's use this time of relative calm to answer some questions we need to consider before we break up the big banks.
The first one has to be: do we, as a country, need large banks? Do these institutions keep the United States and its largest corporations competitive? What would happen to our economy if we didn't have large financial conglomerates with a global presence?
If the consensus is that we don't need big banks, then how big is too big? If $2 trillion is too big, is $1 trillion? How about $500 billion? We need to do some research into what size is the "right" size. Surely we need some banks that are sizable, but how big?
And is this solely about company size, or is structure just as important?
What's the best way to cut the giants down to size? Is it a strict asset cap, concentration trigger or a percentage of gross domestic product? Should we break companies up by product, or by geography?
What sorts of repercussions should we anticipate? For example, if the United States entered a recession and GDP decreased, then our biggest banks would have to shrink to stay within the new legal limits. Would that be good economic policy?
How about the shadow financial system? We need a better understanding of what would happen beyond the federal safety net if we broke up the big banks. How much of what they do now — of what is supervised by federal regulators — would simply move to other, less-regulated providers?
And what would happen to credit availability? Maybe nothing, but we ought to know that with some confidence before proceeding with any plans to dismantle the biggest banks.
Let's also explore bankruptcy alternatives more deeply. The focus is almost exclusively on the "too big" part of TBTF. But the "to fail" part is just as important, and we need to carefully consider if we can make the bankruptcy system work for financial companies.
There are hundreds, maybe thousands, of academics — many of them working for federal agencies — studying financial services and yet few seem to be tackling these sorts of fundamental questions.
I get that there are no "right" answers. But knowing more about the potential consequences of breaking up the largest banks can only lead to better policymaking. It's certainly better than plucking some formula out of the blue or instituting some random size cap.
"Too big to fail" is only going to be tamed over time and with a lot of thought.
And while we lay the foundation for smart policy decisions, we can watch the Dodd-Frank Act unfold.
We can see whether living wills lead to real changes at the largest institutions. We can see whether the higher costs of being big — stricter capital and liquidity standards as well as limits on leverage and counterparty risk — lead companies to downsize on their own. Shareholders, too, may force some companies to get smaller or simpler or both.
We've seen how shotgun policymaking turns out. Let's aim higher.