U.S. Banks Too Big to Fail, or Just Too Big?

Inter Press Service

WASHINGTON, Apr 05 (IPS) - Following last week’s approval of U.S. Senate bills that critics say would weaken a major financial reform law known as Dodd-Frank, watchdog groups here are cautioning that banks deemed “too big to fail” still pose a risk to U.S. and international economic security.

“Too big to fail” was a term associated with the 2008 Troubled Assets Relief Programme (TARP), which gave 700 billion dollars in taxpayer money to rescue large U.S.-based banks whose collapse could have had a devastating impact on global economic security.[pullquote]3[/pullquote]

At a panel discussion here in Washington on Wednesday, political leaders and regulators urged the break-up of big banks as the only viable solution to what they say is still a systemically dangerous concentration of power.

“You’re not going to win this tinkering with the rules,” Neil Barofsky, former special inspector general of TARP and author of a new book on the issue, "Bailout", said at the headquarters of Public Citizen, a consumer rights advocacy group. “You have to go to the source of these corrupting influences ... You have to break up the banks.”

The push against financial regulation flexed its muscle in Congress last week, as Senate bills watering down Title VII of Dodd-Frank, which deals with the especially risky derivatives markets, were approved. The bills now proceed to a floor vote.

That move has renewed a call from regulation proponents to curb the political power of financial institutions, which some say is possible only by ending too-big-to-fail.

Supporters of this move point to the central problem in the too-big-to-fail philosophy: that protecting banks from the consequences of their own actions shields them from accountability and, ultimately, can encourage risky behaviour.

“I think as long as [the too-big-to-fail mentality] exists, the administration of justice is severely undermined in this country,” said Brooksley Born, a former chairperson of the Commodity Futures Trading Commission (CFTC), a government regulator.

Born is known for pushing for increased regulation of the derivatives market, an especially risky slice of trading activity, during the 1990s, calling this market the “hippopotamus under the rug”. Her concerns were rebuffed at the time by Federal Reserve Chairman Alan Greenspan and, under pressure from the financial lobby, Congress eventually passed legislation prohibiting derivatives regulation.

A decade later, Born’s concerns were vindicated by events that played out in the 2008 collapse, which largely began in the derivatives market.

Regarding the extent to which too-big-to-fail shields banks from prosecution, Born cited comments made by U.S. Attorney General Eric Holder last month, especially his admission that “it does become difficult for us to prosecute [the banks] when we are hit with indications that if you do prosecute … it will have a negative impact on the national economy.”

She also revealed a less public example of the government protection she says she witnessed firsthand as a member of the Financial Crisis Inquiry Commission, an official task force appointed to investigate the causes of the 2008 financial crisis.

“The Financial Crisis Inquiry Commission was given a mandate to focus on causes of the financial crisis, but our statute also said that if we came across evidence of violations of U.S. law, it was our obligation to report those violations to the Justice Department,” she said.

“We made a number of such referrals … and I have not seen anything happen on those.”

That failure, she suggests, was just one symptom of a broader illness.

“I became convinced there was a philosophy in this administration of letting the banks earn their way out of the insolvency they were in,” she said, “that the banks had to be protected from the rule of law in order to preserve the financial system.”

Cognitive capture

For some, though, the prospect of breaking up the banks is both too abstract and too politically unviable to be discussed as a serious policy proposal.

Dennis Kelleher, CEO of Better Markets, a financial reform advocacy group, says that any move to break up the banks would come in one of two guises: either as a prohibition on banks dealing with more than a certain amount of gross domestic product, or government regulators using all the authority already vested in Dodd-Frank.

“The Federal Reserve could say banks with more than 50 billion dollars pose a significant threat to the financial stability, and they have to put up 50 percent of capital [in case of extreme losses],” Kelleher told IPS. “If they did that - which they have the power to do - that wouldn’t be ‘breaking up the banks’, but that would eliminate the too-big-to-fail threat.”

Under this approach, the key problem is ensuring that regulators are aggressive enough, and especially strong enough to counter Wall Street tropes that invoke the common citizen as the main victim of regulation.

“[Regulators] actually believe the spin that comes from Wall Street and its lobbyists,” Kelleher says, calling it “cognitive capture, reinforced by a culture that equates money with brains”.

Regulation proponents, though, seemed confident that shifting public opinion was becoming a formidable opposition to these entrenched interests, even if the time is not yet ripe for putting a hard cap on the size of major banks.

“If there is another major megabank blow-up, it could easily change the political dynamics,” Kelleher told IPS. “While these too-big-to-fail banks have political support … [that support] is broad but it’s not deep - it’s very fragile.”