Weissman: More Must Be Done to Curtail Size of Banks

Posted May 7, 2010 at 3:02pm

Politicians of all stripes insist that the era of “too big to fail” banks and financial institutions must come to an end.

[IMGCAP(1)]With a partisan dispute evidently now resolved, it appears the Senate financial reform legislation will give regulators new powers (“resolution authority”) to wind down failing megabanks. This is a good thing.

But a resolution authority is not enough to prevent future bailouts.

To protect our economy and our democracy, we must, to put it colloquially, break up the banks. Sens. Sherrod Brown (D-Ohio) and Ted Kaufman (D-Del.) will introduce an amendment to the financial reform bill to do just that.

The problem is not that regulators and legislators are not sincere. It’s that, in times of crisis, when many institutions are facing insolvency, fear of the impact on the broader economy will almost always lead the government to bail out megabanks rather than let them fail. The only way to avert this problem is to make sure that institutions are not so big that their closure would threaten the financial system’s stability — and that the institutions are not so big that they can leverage political influence to demand a rescue.

Consider the mismanaged bailouts of Citigroup and AIG. Much less than a lack of legal authority, it was a political calculation that prevented the government from taking over Citi or imposing a haircut on AIG’s derivative counterparties.

That political failure is directly tied to the political power and influence of the mega financial institutions. With their campaign cash, heavy lobby investments, support for think tanks and academics, and revolving-door staffing of key government outposts, they shape legislative and regulatory conventional wisdom.

The attendant grossly distorted political process results in a deregulated environment that enables the big banks to rip off consumers, engage in wild speculation, manipulate their books, profit from bubble economics — and grow ever larger. Financial markets are severely more concentrated than they were a decade and a half ago. (The top three commercial banks control more than a third of all bank assets, three times the level of 1993, according to economists at the University of Massachusetts Amherst.) The biggest banks are now bigger than ever.

There are still more problems with the megabanks. Bigger banks take more risks — and thereby put the entire financial system at risk. They take on more leverage than smaller banks and trade much more in risky derivatives. The top five banks own 96 percent of all U.S. bank-owned financial derivatives.

Because the market believes the biggest banks are “too big to fail,” they are able to borrow money at cheaper rates than smaller banks — a subsidy worth $34 billion a year, according to estimates by the Center for Economic and Policy Research.

On the consumer side, there is evidence that larger banks charge higher overdraft, checking account and ATM fees, and serve communities less well.

Some defenders of the megabanks say they are necessary to be competitive in the global economy. But exactly how has the megabank-induced financial crisis helped the United States become more competitive in the global economy? Big corporations don’t need banks as large as today’s behemoths — they managed just fine a decade and two decades ago, when banks were smaller, and, in any case, they typically spread their banking business among multiple institutions. And, economists like Simon Johnson say, there are no economies of scale for banking at institutions with more than $100 billion in assets. (J.P. Morgan is about 20 times that size.)

A solution is at hand. Sens. Brown, Kaufman, Bob Casey (D-Pa.), Sheldon Whitehouse (D-R.I.) and Tom Harkin (D-Iowa) have introduced the SAFE Banking Act of 2010, which would impose caps on bank size and require the nation’s largest financial institutions to sell assets or spin off operations to come under the size cap.

Fiery rhetoric will not end the too-big-to-fail era. We will end that era not with protestations by regulators never to bail out again, but by insisting that financial institutions cannot be too big, period — and that is why it is imperative that the SAFE Banking Act be included in the final financial reform legislation.

Robert Weissman is president of Public Citizen.