Why Congress Should Not Fix 'Too Big to Fail'
Wharton professor David Zaring filed this guest blog post:
At the hearing earlier this week before the Joint Economic Committee, nobody liked banks that were “too big to fail.” Thomas Hoenig decried the “financial megamergers” that led to the problem in the first place. Simon Johnson regretted that “[f]inance became big relative to the economy, largely because of … political decisions” deregulating the banks that should be revisited.
Joseph Stiglitz said that “[t]here are but two solutions: breaking up the institutions or regulating them heavily. For reasons that I will make clear, we need to do both.” Johnson and Hoenig agreed.
What can we do about oversized banks? And are they really so bad?
I’ll consider the solutions first, and then briefly look at the problem. Johnson proposes solving 'Too Big To Fail' through trust-busting. Hoenig suggests conservatorships like the one the Federal Deposit Insurance Corp. imposed on Continental Illinois. I will add leverage caps to the mix, as the G20 suggested that it would support a multinational approach along those lines.
In my view, none of these strategies to shrink the banks requires legislation from Congress, although both Hoenig and Johnson encourage the modernization of those laws. If you think that banks play an outsized role in the political process, or if you think that banking reform legislation will take years to complete, you should be glad to hear this.
It's true that the principal antitrust laws have not been amended in over a century. But that is because antitrust law is a flexible, judge- and prosecutor-made doctrine. In the 1980s, the Department of Justice decided to take a much more hands-off approach to large market share. That decision survived the Reagan administration, and it has been quite popular with economists (and even more popular with law professors).
But there is no reason it could not be revisited now. And if the Justice department wants to focus its attention on banks instead of, say, health care providers, the beauty of those old, broad statutes is that they can be easily interpreted to permit that new enforcement choice.
And the murky powers of conservatorship that the FDIC and Federal Reserve have long had were, if anything, clarified and increased with the 1991 passage of legislation in the aftermath of the S&L crisis. That gave the FDIC and Fed “prompt corrective action” powers to impose conservatorships quickly.
Finally, federal banking regulators have always had the power to devise minimum capital requirements for banks (say, by keeping 8.5 percent of your capital in cash on hand); leverage caps work essentially the same way.
These regulatory fixes are “stroke of a pen” fixes. We might still want a congressional endorsement of them, at least eventually. And if we want to “lock in” bank trust-busting, or require the government to turn to conservatorships before it turns to bailouts, then we will want that legislation immediately. But I don’t think we need it to begin reforming banking now.
But should we reform banking now? Is too big to fail really so bad? Given the regularity of financial panics, I think it probably is. One cautionary note, however. 'Too Big to Fail' doesn’t have to stand for an implicit government guarantee. It could stand for a sensible strategy of scope, economies of scale, and diversification. Investors often want companies to do those things. German, Swiss and Japanese banks grew very big partly, I suspect, because their regulators concluded that their size and sophistication meant that they really couldn’t fail. Those banks are still very big (some of the German and Swiss banks might even be healthy), suggesting that many still appear to believe, unlike the witnesses at the JEC hearing, that size can equal strength.
--David Zaring, assistant professor of legal studies at the Wharton School of Business.
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