Too Big to Suc­ceed

They re­al­ize that more must be done to ad­dress a threat that re­mains in­creas­ingly a part of our econ­omy: fi­nan­cial in­sti­tu­tions that are "too big to fail."

The Pak Banker - - Editorial5 - Thomas M Hoenig

THE world has ex­pe­ri­enced a se­vere fi­nan­cial cri­sis and eco­nomic re­ces­sion. The Trea­sury and the Fed­eral Re­serve took ac­tions that saved busi­nesses and jobs and may very well have saved the econ­omy it­self from ruin. Still, the pub­lic seems un­grate­ful, ex­press­ing anger at these in­sti­tu­tions that saved the day. Why?

Amer­i­cans are an­gry in part be­cause they sense that the govern­ment was as much a cause of the cri­sis as its cure. They re­al­ize that more must be done to ad­dress a threat that re­mains in­creas­ingly a part of our econ­omy: fi­nan­cial in­sti­tu­tions that are "too big to fail."

Dur­ing the 1990s, Congress, with en­cour­age­ment from aca­demics and reg­u­la­tors, re­pealed the Glass-Stea­gall Act, the De­pres­sion-era law that had barred com­mer­cial banks from un­der­tak­ing the riskier ac­tiv­i­ties of in­vest­ment banks. Fol­low­ing this ac­tion, the reg­u­la­tory author­ity sig­nif­i­cantly re­duced cap­i­tal re­quire­ments for the largest in­vest­ment banks.

Less than a decade af­ter these changes, the in­vest­ment firm Bear Stearns failed. Bear was the small­est of the "big five" Amer­i­can in­vest­ment banks. Yet to avoid the dam­age its fail­ure might cause, bil­lions of dol­lars in pub­lic as­sis­tance was pro­vided to sup­port its ac­qui­si­tion by JPMor­gan Chase. Soon other large fi­nan­cial in­sti­tu­tions were found to also be at risk. These firms were re­quired to ac­cept bil­lions of dol­lars in cap­i­tal from the Trea­sury and were pro­vided hun­dreds of bil­lions in loans from the Fed­eral Re­serve.

In spite of the pub­lic as­sis­tance re­quired to sus­tain the in­dus­try, lit­tle has changed on Wall Street. Two years later, the largest firms are again op­er­at­ing with bonus and com­pen­sa­tion schemes that re­flect suc­cess, not the re­al­ity of re­cent fail­ures. Con­trast this with the hun­dreds of smaller banks and busi­nesses that failed and the mil­lions of peo­ple who lost their jobs dur­ing the Wall Street-fu­eled re­ces­sion.

There is an old say­ing: lend a busi­ness $1,000 and you own it; lend it $1 mil­lion and it owns you. This lat­est cri­sis con­firms that the eco­nomic in­flu­ence of the largest fi­nan­cial in­sti­tu­tions is so great that their chief ex­ec­u­tives can­not man­age them, nor can their reg­u­la­tors pro­vide ad­e­quate over­sight.

Last sum­mer, Congress passed a law to re­form our fi­nan­cial sys­tem. It of­fers the prom­ise that in the fu­ture there will be no tax­payer-fi­nanced bailouts of in­vestors or cred­i­tors. How­ever, af­ter this round of bailouts, the five largest fi­nan­cial in­sti­tu­tions are 20 per­cent larger than they were be­fore the cri­sis. They con­trol $ 8.6 tril­lion in fi­nan­cial as­sets - the equiv­a­lent of nearly 60 per­cent of gross do­mes­tic prod­uct. Like it or not, these firms re­main too big to fail.

How is it pos­si­ble that postcri­sis leg­is­la­tion leaves large fi­nan­cial in­sti­tu­tions still in con­trol of our coun­try's eco­nomic destiny? One an­swer is that they have even greater po­lit­i­cal in­flu­ence than they had be­fore the cri­sis. Dur­ing the past decade, the four largest fi­nan­cial firms spent tens of mil­lions of dol­lars on lob­by­ing. A mem­ber of Congress from the Mid­west re­luc­tantly con­firmed for me that any can­di­date who runs for na­tional of­fice must go to New York City, home of the big banks, to raise money.

What can be done to rem­edy the sit­u­a­tion? Af­ter the Great De­pres­sion and the pas­sage of Glass-Stea­gall, the largest banks had to spin off cer­tain risky ac­tiv­i­ties, and this cre­ated smaller, safer banks. Tak­ing sim­i­lar ac­tions to­day to re­duce the scope and size of banks, com­bined with leg­isla­tively man­dated debt-toe­quity re­quire­ments, would re­store the in­tegrity of the fi­nan­cial sys­tem and en­hance eq­uity of ac­cess to credit for con­sumers and busi­nesses. Stud­ies show that most op­er­a­tional ef­fi­cien­cies are cap­tured when fi­nan­cial firms are sub­stan­tially smaller than the largest ones are to­day.

These firms reached their present size through the sub­si­dies they re­ceived be­cause they were too big to fail. There­fore, di­min­ish­ing their size and scope, thereby re­duc­ing or re­mov­ing this sub­sidy and the com­pet­i­tive ad­van­tage it pro­vides, would re­store com­pet­i­tive bal­ance to our eco­nomic sys­tem.

To do this will re­quire real po­lit­i­cal will. Those who con­trol the largest banks will ar­gue that such ac­tion would un­der­mine fi­nan­cial firms' abil­ity to com­pete glob­ally. I am not per­suaded by this ar­gu­ment. His­tory sug­gests that fi­nan­cial strength fol­lows eco­nomic strength. A com­pet­i­tive, ac­count­able and suc­cess­ful do­mes­tic eco­nomic sys­tem, sup­ported by many in­no­va­tive fi­nan­cial firms, would re­store the United States' eco­nomic strength.

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