The issue of too-big-to-fail banks (TBTF) was to be addressed by America’s politicians, and the idea of dismantling some of these institutions was talked about by regulators and legislators. Regulations and laws were enacted to prevent future bailouts of TBTF banks.
“Dodd-Frank says explicitly that American taxpayers won’t again ride to the rescue of troubled financial institutions. It proposes to minimize the possibility of an Armageddon by revamping the regulatory architecture,” according to the Federal Reserve Bank of Dallas 2011 Annual Report.
Yet today, the TBTF banks have become larger, and many of the smaller banks were gobbled up by the medium- and large-sized banks.
In 1970, America’s five largest banks held 17 percent of America’s banking assets; 12,500 smaller banks accounted for 46 percent of U.S. bank assets; and 95 medium and large banks held 37 percent of U.S. bank assets.
By 2010, the top five banks, JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., and Goldman Sachs Group Inc., held 52 percent of U.S. banking assets; 32 percent were held by the medium and large banks; and the smaller banks had dwindled to 5,700 institutions, holding 16 percent of U.S. bank assets.
“Concentration in the financial sector is anything but natural. … Big banks backed by government turn these manageable episodes into catastrophes. Greater stability in the financial sector begins when TBTF ends and the assumption of government rescue is driven from the marketplace,” the Federal Reserve report suggests.
Meddling With TBTF Banks
On Nov. 4, 2011, the Financial Stability Board (FSB) released a global list of 29 banks considered to be systemically important financial institutions (SIFI). The critieria for determining SIFIs was issued by the Bank for International Settlements (BIS) in November 2011 and is available on the BIS website.
The eight U.S. banks on the list are Bank of America, Bank of New York Mellon, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, State Street, and Wells Fargo. Additionally there were four banks based in the United Kingdom, four banks based in France, and three banks based in Japan.
“The list of G-SIFIs [G stands for G20, the group of 20 Finance Ministers and Central Bank Governors] will be updated annually and published in November every year,” the FSB release states.
The list may be shortened, as some banks have improved their financial wherewithal. Furthermore, legislation as enacted, such as the Dodd-Frank Act, has set up a structure that stops banks from turning into TBTF banks.
Dodd-Frank says explicitly that American taxpayers won’t again ride to the rescue of troubled financial institutions.
—Federal Reserve Bank of Dallas 2011 Annual Report
“New laws such as the Dodd-Frank Act have established a framework to resolve SIFIs without the need for government ‘bail-outs,’” an Oct. 3 discussion on the Global Economic Intersection website suggests.
“A first banking list containing 29 company names was published during the G-20 meeting of November 2011, while insurance was put on a longer timeline,” the Geneva Association Insurance and Finance Program states in an April 12 publication.
The paper goes on to say that systemic risk has been part of the insurance industry’s vocabulary only for a short time. But if certain insurance activities conducted by a financial company, excluding those of basic insurance, could risk the downfall of the worldwide financial system, that company should receive the SIFI designation.
“Burdening inherently stable activities such as those of core insurance with additional costs does not provide additional benefits for the economy. … It would also be a distortion of the free market if G-SIFI status provided a company with a competitive advantage such as governmental guarantee,” according to the Geneva Association paper.
Regulators Should Be Made Accountable
“The financial industry’s grip on regulators and lawmakers was, and still is, a major problem that has to be solved,” said Neil Barofsky, former special inspector general for the Troubled Asset Relief Program, according to an Oct 26 article on the American Banker.
Barofsky charged that those implementing the new regulations have graduated from a job at a bank to the government and thus are on the side of the fence that needs to be regulated.
It was suggested that the Home Affordable Modification Program (HAMP) was a farce because there were no enticements for the banks to buy into the program. All the program did was give homeowners a little hope, but in the end, it led them down the garden path into foreclosure.
Apparently, according to Barofsky, Treasury Secretary Timothy Geithner literally said during a 2009 meeting that HAMP would “foam the runway for banks.” Therefore, instead of reining in the banks, they are bigger now than they were before the financial meltdown.
“Barofsky sees little prospect for improving the system until the government rejects the presumption that some financial institutions are too big to fail,” according to the American Banker article.
Addressing Initiatives to Solve TBTF Issue
“Progress has been made over the past few years towards eliminating too-big-to-fail, with further progress on implementation planned. But today’s task is even more daunting than before the crisis. The big banks are even bigger. The system itself is more concentrated,” said Andrew G. Haldane, executive director at the Bank of England, in an Oct. 25 speech at the Institute of Economic Affairs, United Kingdom.
Haldane suggests that reforms in the form of regulations didn’t fail, but were successful. The reason why they didn’t fully accomplish what they set out to do is because more programs are needed to complete the transformation of the banking sector.
There are several ideas he brought forward, such as increasing the capital surcharge, which could possibly increase as the bank grows in size. Secondly, downsizing banks would be an option, although the Dodd-Frank Act limits the deposit market share for a U.S. bank to 10 percent.
Big banks backed by government turn these manageable episodes into catastrophes.
—Federal Reserve Bank of Dallas 2011 Annual Report
Thirdly, banks could not operate as commercial and investment banks at the same time. Lastly, changing the competitive environment for oversized banks and creating an environment that allows new entries into the banking sector could be an option.
Haldane does not only state alternatives that could change the TBTF paradigm, but also points out that those against implementing the abovementioned options have a strong case that could turn the table in their favor.
“A powerful counter-argument to all of these more radical proposals is that they could erode the economies of scale and scope associated with large banks. These economies clearly do exist in banking, as they do in other industries,” Haldane said.
Preventing Bank Mergers
“The government’s bailouts, however, should not be the focus of the public’s frustration and outrage. The real culprits are the bank mergers that created mammoth banks causing the government to feel forced to save private banks with public money,” according to a Santa Clara University Law Review article, published in September.
The law review argues that without sizing down a bank through more regulatory actions and reversing the deregulation efforts that finally led to the financial meltdown, the U.S. government could be charged with “systemic negligence.”
By restricting banks from remaining or growing into mammoth entities, the U.S. economy would gradually stabilize and any future collapse of today’s TBTF banks would be avoided.
“Mergers creating TBTF banks violate the BMA. They are anticompetitive and clearly not in the community’s best interests,” according to the Santa Clara Law Review.
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