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Kaufman: No Bank Should Be ‘Too Big to Fail’

Over the past few weeks, there’s been a lot of talk — and much ink spilled — about solving the problem of banks that are “too big to fail.” Sen. Sherrod Brown (D-Ohio) and I, along with Sens. Bob Casey (D-Pa.), Jeff Merkley (D-Ore.), Sheldon Whitehouse (D-R.I.), Tom Harkin (D-Iowa) and Roland Burris (D-Ill.), introduced a bill to place strict limits on the size and leverage used by systemically significant banks and nonbanks alike.

The current financial regulatory bill is a good bill and has many provisions that I support. Indeed, the Brown-Kaufman amendment is a complementary piece of legislation, not a substitute. But as Moody’s reports, “the proposed regulatory framework doesn’t appear to be significantly different from what exists today.” And such measures won’t go nearly far enough to protect the economy — even as millions of Americans are still suffering from unemployment and home foreclosures.

The Brown-Kaufman amendment is not as dramatic as it seems. Very large banks will still exist under this bill. But they won’t be so big that they are “too big to manage and too big to regulate,” as former Federal Deposit Insurance Corp. Chairman Bill Isaac has said. And the leverage those banks use — the ratio of capital to assets — which is the very basis for how risky they become, will be statutorily capped at 6 percent, twice as conservative as current law.

The bill would also cap at 10 percent a bank holding company’s share of the nation’s total amount of deposits, and it would limit nondeposit liabilities of a bank holding company to 2 percent of gross domestic product and nondeposit liabilities of a nonbank financial institution to 3 percent of GDP.

In fact, the extra layer of protection provided by this legislation is the least we should do. The federal government cannot continue to subsidize these megabanks and permit them to grow by taking on ever-greater risk and speculation. Dean Baker and Travis McArthur of the Center for Economic and Policy Research compared the borrowing costs of the 18 largest banks (all of which have more than $100 billion in assets) to smaller ones. They estimated that the effective government subsidy — because of the implicit guarantee that they are “too big to fail” — results in a 70-to-80-basis-point advantage over smaller banks, resulting in lower borrowing costs equal to approximately $34 billion.

Under Brown-Kaufman, big financial conglomerates such as Bank of America and Citigroup will still have balance sheets that exceed $1 trillion — about half of their current size. Citigroup would be about the size that it was in 2002 — when it was still very competitive in the U.S. and overseas. The balance sheet of Goldman Sachs would be scaled down from $850 billion to a more reasonable level of just above $300 billion, or around $450 billion if Goldman exits the bank holding company structure. Indeed, Goldman Sachs’ assets didn’t exceed $100 billion until 2003. The firm is currently well over 10 times the size it was when it went public just over 10 years ago.

Nonetheless, I continue to hear three arguments defending the size of megabanks.

Megabank supporters say there are economies of scale that allow $2 trillion banks to better service global U.S. corporations and help us compete worldwide. But there is no evidence to support this claim and no academic studies proving that in banking, bigger is better and more efficient beyond $100 billion in assets.

They argue that the United States needs megabanks in order to “compete” with massive foreign banks. Again, there is no evidence that proves this is the case. Many of these giant foreign banks also have a history of government involvement and many, including one of the largest, the Royal Bank of Scotland, have been recipients of massive bailouts. Given these circumstances, other countries face just as urgent a need to break apart their megabanks.

Finally, I am told that “most observers” think that breaking up the big banks would lead to more risk, not less, because bigger banks are more diversified, and therefore less risky than smaller banks. That makes no sense to me. As the governor of the Bank of England, Mervyn King, recently observed, “Banks who think they can do everything for everyone all over the world are a recipe for concentrating risk.”

The best argument against megabanks is made by former Federal Reserve Chairman Alan Greenspan, clearly no populist, in a recent speech at the Brookings Institution, in which he rebutted the view that it is in the country’s best interests to have a concentrated collection of very large banks.

Greenspan said: “For years, the Federal Reserve had been concerned about the ever-larger size of our financial institutions. Federal Reserve research had been unable to find economies of scale in banking beyond a modest-sized institution. A decade ago, citing such evidence, I noted that ‘megabanks being formed by growth and consolidation are increasingly complex entities that create the potential for unusually large systemic risks in the national and international economy should they fail.’”

In the 1930s, this body had the courage and foresight to pass laws that maintained U.S. financial stability for generations. But a decade ago, too many people forgot the wisdom of those laws. That is our challenge today. We can either do nothing, which would be dangerous and irresponsible. Or we can pass laws that set clear rules to protect the American people from ever having to bail out megabanks again.

Sen. Ted Kaufman is a Democrat from Delaware.

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