Big Banks Should – And Can – Be Shrunk If Needed, Experts Say
If the largest banks can only be run so recklessly that they harm the economy as well as themselves, they should be broken up, Angelides said in a talk at the Center for National Policy, an independent Washington D.C. think tank.“By 2011, the top 10 banks in this country held 77 percent of the nation’s banking assets. The top five banks – JPMorgan, Citi, Bank of America, Goldman [Sachs] and Morgan Stanley – held $7.9 trillion in assets and 95 percent of the $304 billion in [OTC] derivatives held by U.S. bank holding companies,” Angelides said.
“These banks are too big to fail. They’re too big to manage. They’re too big to regulate. They’re too complex to understand and they’re too risky to exist. And the bottom line is they offer very little benefit,” Angelides added.
In calling for divestiture as a remedy for such institutions, Angelides echoed comments by, among others, former Federal Deposit Insurance Corporation chairman Sheila Bair and Richard Fisher, president of the Federal Reserve Bank of Dallas.
There are legal remedies that courts or regulators can use to break up the banks, other regulators have said.
Backdrop to calls for a breakup
In a January 2011 report, the Democratic-appointed majority of the Financial Crisis Inquiry Commission (FCIC) found that the credit bubble and crash were not an inevitable part of a normal business cycle but resulted from a confluence of reckless bankers and feckless regulators. The crisis had been predicted, it could have been avoided, and once it started it could have been ameliorated if not stopped, the majority concluded in a report Angelides signed off on.
The Republican-appointed minority dissented from the FCIC majority report, and one GOP appointee, Peter Wallison, issued his own separate findings and conclusions.
But more alarming even than the majority’s findings is that the reforms the panel recommended are being beaten back by the same forces the report found had contributed to the crisis in the first place, Angelides said.
Worse yet, financial firms that never owned up to operating under a model of keeping the gains but offloading the losses still play a disproportionate role in regulating themselves and could drag the U.S. and the global economies back into danger, Angelides said.
The crisis was not, as the industry maintained, “the result of powerful and uncontrollable forces coming together in a perfect storm … a matter of Mother Nature, of risk models gone haywire,” Angelides said. U.S. regulators have the means to protect the economy from reckless financial practices, systemic shocks and inadequate oversight, but it is unclear whether they have the will to defy the influence finance has over its overseers.
“The world has changed but Wall Street has not,” Angelides said. “It was spared any consequences of its actions and any real rethinking of what it must do. Practices that brought this country to its knees are still very much alive.”
Before chairing the FCIC, and after a career in business, Angelides was twice elected California state treasurer as a Democrat and was the state’s party chairman. But the calls to break up too-big-to-fail banks are not split on the same party lines as the FCIC report. Bair unsuccessfully sought the Republican nomination for a Kansas Congressional seat, and Fisher lost a Senate bid to Texas Republican Kay Bailey Hutchison.
What is to be done?
The biggest banks, by their actions that contributed to the crisis, “have made a very eloquent case for their demise,” Angelides said.
Reforming them requires shedding light on and monitoring “disgraceful and dangerous derivatives,” and implementing a tougher Volcker rule, “with teeth,” he said.
More recent evidence proves that the riskiest practices tend to be taken by systemically important banks with federal backing, and that practices found in one bank tend to exist in their peers, Angelides said.
Angelides said he is interested in seeing whether there will be clawbacks over excessive risk-taking, as in the real world, or whether these practices will continue as long as compensation practices reward deal-making without regard to long-term performance.
But excessive risk-taking will continue until banks accept that no model can factor in the human elements of faith, fear, greed and herd behavior, Angelides said.
A concerted effort to get strong Dodd-Frank Act rules in place — putting over-the-counter derivatives on exchanges, designating systemically important financial institutions and requiring them to have higher capital standards, is essential to economic recovery. But these may not be enough to counter the largest banks’ inordinate market and political power, and their growing concentration, Angelides said.
Angelides called for a “modern era of trust-busting” and ending “reckless recidivism” by banks. If there was ever an economy of scale in banking, the U.S. financial system has passed that point, and the cost of intermediation is higher now than it was a century ago, with an industry that is so much less competitive than it should be that the largest banks present a “clear and present danger” to the economy and the nation.
A century-old throwback or a modern tool?
It may seem outdated to call for breaking up banks through the Sherman Act of 1890 and the Clayton Act of 1914, but these laws are still in use. While the largest banks individually lack the monopolistic power Standard Oil had that led to its breakup through a 1911 U.S. Supreme Court ruling, they represent an oligopoly that has gotten bigger during the crisis, Angelides said.
Banks being “too big to fail” because of their size and interconnectedness was the focus of a Columbia Law School program last week sponsored by the American Bar Association section on antitrust law.
Federal and state laws protect against oligopolistic market dominance through collusion, concentration and excluding potential market entrants by, among other things, standard-setting. Depending on the circumstances, government backing, and greater access to, and a lower cost of, capital can be anti-competitive factors, said Scott Hemphill, the New York Attorney General’s antitrust bureau chief.
Being “too big to fail” is not a traditional antitrust factor, but the laws can apply if a dominant player is induced to engage in excessive risk taking with less downside risk. Such a player can create efficiencies but its size and power “can give rise to inefficiencies as well,” and can quash as well as promote innovation, Hemphill said.
Instead of breaking banks into many small parts, along the model of Standard Oil and, more recently, the AT&T telephone network, banks could be limited to organic growth and be generally barred from growing through acquisitions and mergers, Hemphill said.
But “large financial institutions are not directly analogous to Standard Oil or Ma Bell,” Hemphill acknowledged. Another approach could be through Dodd-Frank, which added the Financial Stability Oversight Council (FSOC) as an arbiter and participant among others, including antitrust enforcement agencies, he said.
Divestiture can, however, be ordered “if the conduct is sufficiently egregious,” Hemphill said.
The regulators’ new Dodd-Frank toolkit
In addition to the Volcker rule limiting risky activities by big banks, Dodd-Frank tools can reduce the negative impact of large bank size and power, said Thomas C. Baxter Jr., Federal Reserve Bank of New York general counsel. These include:
- section 604, which requires considering risks to the banking system as a whole in determining whether to approve a bank or bank holding company’s expansion by merger, acquisition or consolidation.As the Federal Reserve Board said February 14 in approving the application of Capital One Financial to acquire a unit of bank ING Groep N.V., the board “will generally find a significant adverse effect if the failure of the resulting firm, or its inability to conduct regular-course-of-business transactions, would likely impair financial intermediation or financial market functioning so as to inflict material damage on the broader economy.”The board said it will consider factors including the resulting firm’s size; its interconnectedness with the banking or financial system; the availability of substitute providers for any critical products and services; the extent to which it contributes to systemic complexity; and its cross-border activities.The board said it will also “consider qualitative factors, such as the opaqueness and complexity of an institution’s internal organization, that are indicative of the relative degree of difficulty of resolving the resulting firm. A financial institution that can be resolved in an orderly manner is less likely to inflict material damage to the broader economy.”
- section 165(b), which has higher capital and liquidity requirements that make it more expensive to operate a very large, very interconnected, and very complex and opaque institution; and divestiture can be ordered if the FSOC, in reviewing a bank’s “living will,” determines that the bank is “too big to resolve” through Dodd-Frank or bankruptcy; and
- section 121, under which the FSOC can, by a two-thirds vote, limit a bank’s expansion and order break-up remedies.
There are different factors but similar remedies for “too big to fail” under antitrust laws and Dodd-Frank, but the regulators are more likely to try their Dodd-Frank tools and are already doing so, the panelists said.