It was the insult heard 'round the banking world. The chief executive of the nation's largest bank called me a "jerk" on national television following my comments on the differences between large financial firms and local community banks. I bear no hard feelings against J.P. Morgan Chase's Jamie Dimon, but our disagreement underscores a much deeper rift between how Wall Street firms and Main Street community banks view the post-crisis financial world.
While representatives of the largest financial institutions portray their firms as indispensable to the nation's banking system, many community banks view the proliferation of these massive firms as a distortion of our market-based economy. The consequences of the 2008 bailout persist years later. Allowing the megabanks to keep their profits during the good times while enjoying a federal backstop in times of trouble — a system of privatized gains and socialized losses — incentivizes risky behavior and provides outsized competitive advantages to these institutions.
Freedom to Fail
The result of this moral hazard is a cycle of high-risk behavior followed by taxpayer-funded government intervention. That in turn contributes to reckless and anticompetitive behavior that has led to international interest rate rigging, mortgage securities fraud, electricity market manipulation and municipal bond trading fraud — as well as a wide-scale increase in regulation for banks of all sizes.
The freedom to fail is a vital part of a free market system, and it is absent on Wall Street. In a series of 2014 studies, the Federal Reserve Bank of New York found that the megabanks enjoy a funding advantage relative to their smaller competitors that suggests investors believe the largest banks will be rescued if they run into trouble. The International Monetary Fund released a separate study estimating the 2012 value of the too-big-to-fail subsidy at up to $70 billion in the U.S. Additionally, the Government Accountability Office reported that this funding advantage increases in periods of stress, indicating that the megabanks' too-big-to-fail status will once again be an invaluable asset in future crises. And even former Fed Chairman Alan Greenspan has said that "too big to fail" is as big of a problem now as it was during the crisis.
Reining in Risks
In short, "too big to fail" tangibly benefits the biggest banks, distorts free markets, incentivizes risky behavior and puts our financial system in jeopardy. Curbing this threat to the system requires a combination of higher capital and leverage requirements, enhanced liquidity standards, activity restrictions, concentration limits, limitations of the federal safety net, and an effective resolution authority that provides these institutions the free-market freedom to fail.
Washington has indeed taken steps to address the problem, designating the Federal Deposit Insurance Corp. as the receiver for failing financial firms and requiring systemically important institutions to divest their assets if they do not file credible resolution plans. Meanwhile, the Federal Reserve has proposed new loss-absorbing capacity requirements — including minimum levels of long term debt — for globally significant banks.
But some industry experts would go further. FDIC Vice Chairman Thomas Hoenig proposes splitting the largest institutions' commercial and investment banking operations to restrict access to the taxpayer safety net for nonbank activities. Meanwhile, former Dallas Fed President and CEO Richard Fisher's proposal would restructure overly complex financial firms into multiple business entities subject to a speedier bankruptcy process.
The growth since 2008 of the 12 largest U.S. banks — which now hold nearly 70% of banking industry assets — indicates that the nation's too-big-to-fail problem remains unsolved. Amid this post-crisis increase in industry concentration, no wonder community banks continue to have concerns about Wall Street's impact on the banking sector. From Main Street's perspective, the playing field is skewed in favor of the largest institutions and should be rebalanced in favor of free and fair financial markets.
Camden R. Fine is president and CEO of the Independent Community Bankers of America.