Gretchen Morgenson, writing in the Business section of today’s New York Times, offers a fairly straightforward and succinct explanation of why the financial reforms being proposed in Congress are likely to fail.
The reforms, she says, “would do little to cure the epidemic unleashed on American taxpayers by the lords of finance and their bailout partners.
The central problem is that neither the Senate nor House bills would chop down big banks to a more manageable and less threatening size. The bills also don’t eliminate the prospect of future bailouts of interconnected and powerful companies.
The issue, ultimately, is size. For any financial reform proposal to be more than a Band-Aid, it needs to address the problems of banks growing so big that their failure becomes dangerous for the economy as a whole. They either need to be broken into smaller, less threatening institutions or have their ability to “leverage” limited. (Leverage is the use of debt to supplement an investment and boost its apparent profitibility.)
Such is the view of Richard W. Fisher, president of the Federal Reserve Bank of Dallas.
“The social costs associated with these big financial institutions are much greater than any benefits they may provide,” Mr. Fisher said in an interview last week. “We need to find some international convention to limit their size.”
Limiting their leverage is another way to begin defanging these monsters, Mr. Fisher said. But he concedes that there is little will to do either. “It takes an enormous amount of political courage to say we are going to limit size and limit leverage,” he said. “But to me it makes the ultimate sense. The misuse of leverage is always the root cause of every financial crisis.”
And yet, the financial fixes being proposed failed to address either problem. Miles Mogulescu, writing on Huffington Post, calls the chief proposal a “a moderately helpful financial reform bill” that should “address some of the problems of the banking system that led to the financial crisis and the bailouts,” but one that “may be Too Weak to Succeed by allowing the megabanks to remain Too Big to Fail, thus insuring that the next cycle of boom, bust and bailout remains baked into the system.”
Ouch.
He is urging support of an amendment to the reform bill, one designed to cut to the chase on the issue and force the dismantling of the largest financial institutions. (Petition can be found here.)
Senators Sherrod Brown and Ted Kaufman have introduced the “Safe Banking Act” which would put a hard cap of 3% of Gross Domestic Product on the assets of all bank holding companies. This would mean that that 6 largest banks which now hold assets exceeding 60% of GDP — Citigroup, Bank of America, Wells Fargo, JP Morgan Chase, Morgan Stanley, and Goldman Sachs — would be broken up into smaller banks that would be Small Enough to Fail. This is what Teddy Roosevelt did in 1911 when he broke up the Standard Oil trust.
The Roosevelt precedent is important, because it should insulate the amendment from the inevitable attacks on its consitutionality and Americanness — the chief critical approach used by the pro-business crowd these days. Unlike the Dodd bill and the various compromises being worked out between Democrats and Republicans with the blessing of the White House, the Brown-Kaufman amendment actually goes to the heart of the crisis that left us mired in our current economic mess and nearly pushed us off the precipice. To tinker around the edges while leaving the general outlines of our dysfunctional financial system in place is dangerously foolish.
Congress, as Morgenson says, needs to do more than pass “financial regulations that do not eliminate the heads-bankers-win, tails-taxpayers-lose mentality that has driven most of the bailouts during this sorry episode.”
Companies that are too mighty to fail must be broken up. And incentives in the nation’s regulatory system that reward size with subsidies should not be enshrined into law. They should be eliminated.
Only then will America be safe from toxic banking practices and the burdensome rescues they require.
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