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In Financial Reform, Size (Is All That) Matters

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If Chris Dodd is to be believed, his financial reform bill, which passed the Senate Banking Committee this week, will hit the floor of the Senate right after the two-week recess. Noam Scheiber reports that the Administration settled on financial reform as the next big push because of the opportunity it creates to squeeze Republicans.

The bill differs in certain respects from the version the House passed in December—one difference is the New York Fed provision, which the House bill lacks. But, on Wednesday, Obama told Dodd and his House counterpart, Barney Frank, that he could more or less live with either version, according to an official knowledgeable about the meeting. (Though he stressed that he’d like to combine the toughest elements of both, as with an exemption from derivatives regulation for non-financial companies, which is stricter in Dodd’s bill.) Mostly, he just encouraged them to press ahead, emphasizing the win-win dynamic at work. If Republicans dig in, the president argued, that’s a fight he’d welcome. (Administration officials have seen polling suggesting the public will assume Republicans are carrying Wall Street’s water, regardless of their arguments.) And if Republicans want to join in the effort to rein in Wall Street—well, no one at the White House would turn down a big, bipartisan victory.

I’m not denying the politics of the issue, particularly in the perception of taking on Wall Street. But disregarding the content in favor of the optics risks muddying the message, that Republicans are on the side of the banks. Because the Dodd bill simply lacks most of the fundamental reforms actually needed to solve the problems in our financial industry exposed by the 2008 meltdown, and pretty much every expert surveying the policy knows it. Mike Konczal cites some specifics:

The Senate bill is lacking in many of the essential areas for reform. Here are specific, targeted ways of strengthening the Senate bill:

Hard limits related to both size caps relative to GDP and leverage ratio must be specified in the bill. This will put a floor to the difficulty of resolution and the damage to the economy.

The Volcker Rule should be accepted outright, rather than through the decision of the Financial Stability Oversight Council.

The Bureau of Consumer Financial Protection must have full rule-making authority over non-bank lenders, including auto lenders.

The Bureau of Consumer Financial Protection must keep its lack of preemption over state regulation.

The derivatives section should be included to require all standardized derivatives to trade on an exchange with clearing, keeping with the original financial regulatory reform language introduced by President Obama in June of 2009.

The Financial Stability Oversight Council should not have the ability to alter the derivatives rules, override the Bureau of Consumer Financial Protection or change other regulations by a vote.

Early remediation requirements should be defined as to intervene earlier than the event of financial decline for a large systemically risky financial firm with a rule written by Congress.

There should be more focus on investing in high end, internationally focused position monitoring for large systemically risky financial firms.

In the light of recent scandals, there should be extra language included that targets fraud in accountancy and directly addresses issues of off-balance sheet reform.

Konczal perhaps puts the size and leverage caps right at the top because they represent the biggest failing in the Dodd approach. Frank’s legislation came out of the House with a hard cap on leverage, but in truth, both of them fail to break up the big banks, who can evade regulation and oversight with ease, and demand bailouts when they gamble their way into trouble. Tim Geithner also wants to use hard capital requirements as the basis for managing size, but while this would be preferable to the discretionary approach in the Dodd bill, it doesn’t totally get to the heart of the matter.

It’s beneficial to have resolution authority for financial firms when they fail, but that does nothing to prevent that failure, nor would it be sufficient for a multi-national, multi-connected financial firm. Dodd appeared to concede this earlier in the week, but his bill still misses the mark – too big to fail equals too big to exist. Quoting Sen. Ted Kaufman:

What walls will this bill erect? None. On what bedrock does this bill rest if the nation is to hope for another 60 years of financial stability? Better and smarter regulators, plain and simple. No great statutory walls, no hard divisions or limits on regulatory discretion, only a reshuffled set of regulatory powers that already exist. Remember, it was the regulators who abdicated their responsibilities and helped cause the crisis.

Thus far, on the central aspect of “too big to fail,” financial reform consists of giving regulators the authority to supervise institutions that are too big, and then the ability to resolve those banks when they are about to fail. Upon closer examination, however, the former is virtually the same authority regulators currently possess, while the latter – an orderly resolution of a failing mega-bank – is an illusion. Unless Congress breaks up the mega-banks that are “too big to fail,” the American taxpayer will remain the ultimate guarantor in an almost certain-to-repeat-itself cycle of boom-bust-and-bailout.

We have seen this boom-and-bust cycle in our history. Before the New Deal reform panics and bank runs were a central a central fact of American life. Those reforms made banking boring – reducing the system’s size relative to the economy and reducing overall risk. Deposits may be guaranteed now, but the banks have the ability to gamble with impunity – getting their risk socialized while they keep their profits. Perhaps we can tax size, perhaps we can cap size, but we have to do something along these lines, as Devilstower illustrates.

The problem is that the banks are still as large as they ever were. In fact, thanks to the buyouts of their failed neighbors using loans that we provided, they’re bigger. Citigroup currently has over $2.5

    trillion

in assets. There’s absolutely no evidence that banks need to be even a twentieth of this size to compete internationally, and there’s certainly no evidence that the existence of such banks is good for the economy. The only thing that’s certain is that banks this large provide a huge and looming risk. They are able to take any chance no matter how ridiculous, ignore any warning, reward their executives with a lavishness that would make Caligula blush, and at the end of the day come cap in hand, sure that the government will bail them out.

The solution that Johnson and Kwak propose is one that has been suggested by many others — make the banks smaller. Use anti-trust regulation to break up these enormous banks, and set new limits so that no bank ever again has such a stranglehold on our nation that it becomes immune to its own stupidity.

Paul Volcker seems the most willing to attack the question of size, through his “Volcker rule” on proprietary trading (which according to David Leonhardt, would primarily prevent investment-oriented firms from taking cheap money in the discount window), which included a size cap. He’s speaking in Washington on Tuesday, and he may hold the key to a lasting soution for financial reform that is more than window dressing meant to score political points.

Obviously, reducing the size of the greatest behemoths in the economy will run into major resistance from those behemoths. Reducing the size of the financial industry benefits perhaps every other sector, including the bottom line of the federal government. But the banksters probably feel they can bully politicians into supporting their interests, with the lure of campaign contributions and the time bomb of blowing up the recovery as a carrot and stick, respectively.

We don’t need a banking industry at its present size; it actually restricts productivity across the economy in exchange for fattening bonus checks and stock portfolios. This is a battle worth having, if the President really wants to force a “win-win dynamic” with Republicans.

CommunityThe Bullpen

In Financial Reform, Size (Is All That) Matters

If Chris Dodd is to be believed, his financial reform bill, which passed the Senate Banking Committee this week, will hit the floor of the Senate right after the two-week recess. Noam Scheiber reports that the Administration settled on financial reform as the next big push because of the opportunity it creates to squeeze Republicans.

The bill differs in certain respects from the version the House passed in December—one difference is the New York Fed provision, which the House bill lacks. But, on Wednesday, Obama told Dodd and his House counterpart, Barney Frank, that he could more or less live with either version, according to an official knowledgeable about the meeting. (Though he stressed that he’d like to combine the toughest elements of both, as with an exemption from derivatives regulation for non-financial companies, which is stricter in Dodd’s bill.) Mostly, he just encouraged them to press ahead, emphasizing the win-win dynamic at work. If Republicans dig in, the president argued, that’s a fight he’d welcome. (Administration officials have seen polling suggesting the public will assume Republicans are carrying Wall Street’s water, regardless of their arguments.) And if Republicans want to join in the effort to rein in Wall Street—well, no one at the White House would turn down a big, bipartisan victory.

I’m not denying the politics of the issue, particularly in the perception of taking on Wall Street. But disregarding the content in favor of the optics risks muddying the message, that Republicans are on the side of the banks. Because the Dodd bill simply lacks most of the fundamental reforms actually needed to solve the problems in our financial industry exposed by the 2008 meltdown, and pretty much every expert surveying the policy knows it. Mike Konczal cites some specifics:

The Senate bill is lacking in many of the essential areas for reform. Here are specific, targeted ways of strengthening the Senate bill:

Hard limits related to both size caps relative to GDP and leverage ratio must be specified in the bill. This will put a floor to the difficulty of resolution and the damage to the economy.

The Volcker Rule should be accepted outright, rather than through the decision of the Financial Stability Oversight Council.

The Bureau of Consumer Financial Protection must have full rule-making authority over non-bank lenders, including auto lenders.

The Bureau of Consumer Financial Protection must keep its lack of preemption over state regulation.

The derivatives section should be included to require all standardized derivatives to trade on an exchange with clearing, keeping with the original financial regulatory reform language introduced by President Obama in June of 2009.

The Financial Stability Oversight Council should not have the ability to alter the derivatives rules, override the Bureau of Consumer Financial Protection or change other regulations by a vote.

Early remediation requirements should be defined as to intervene earlier than the event of financial decline for a large systemically risky financial firm with a rule written by Congress.

There should be more focus on investing in high end, internationally focused position monitoring for large systemically risky financial firms.

In the light of recent scandals, there should be extra language included that targets fraud in accountancy and directly addresses issues of off-balance sheet reform.

Konczal perhaps puts the size and leverage caps right at the top because they represent the biggest failing in the Dodd approach. Frank’s legislation came out of the House with a hard cap on leverage, but in truth, both of them fail to break up the big banks, who can evade regulation and oversight with ease, and demand bailouts when they gamble their way into trouble. Tim Geithner also wants to use hard capital requirements as the basis for managing size, but while this would be preferable to the discretionary approach in the Dodd bill, it doesn’t totally get to the heart of the matter.

It’s beneficial to have resolution authority for financial firms when they fail, but that does nothing to prevent that failure, nor would it be sufficient for a multi-national, multi-connected financial firm. Dodd appeared to concede this earlier in the week, but his bill still misses the mark – too big to fail equals too big to exist. Quoting Sen. Ted Kaufman:

What walls will this bill erect? None. On what bedrock does this bill rest if the nation is to hope for another 60 years of financial stability? Better and smarter regulators, plain and simple. No great statutory walls, no hard divisions or limits on regulatory discretion, only a reshuffled set of regulatory powers that already exist. Remember, it was the regulators who abdicated their responsibilities and helped cause the crisis.

Thus far, on the central aspect of “too big to fail,” financial reform consists of giving regulators the authority to supervise institutions that are too big, and then the ability to resolve those banks when they are about to fail. Upon closer examination, however, the former is virtually the same authority regulators currently possess, while the latter – an orderly resolution of a failing mega-bank – is an illusion. Unless Congress breaks up the mega-banks that are “too big to fail,” the American taxpayer will remain the ultimate guarantor in an almost certain-to-repeat-itself cycle of boom-bust-and-bailout.

We have seen this boom-and-bust cycle in our history. Before the New Deal reform panics and bank runs were a central a central fact of American life. Those reforms made banking boring – reducing the system’s size relative to the economy and reducing overall risk. Deposits may be guaranteed now, but the banks have the ability to gamble with impunity – getting their risk socialized while they keep their profits. Perhaps we can tax size, perhaps we can cap size, but we have to do something along these lines, as Devilstower illustrates.

The problem is that the banks are still as large as they ever were. In fact, thanks to the buyouts of their failed neighbors using loans that we provided, they’re bigger. Citigroup currently has over $2.5 trillion in assets. There’s absolutely no evidence that banks need to be even a twentieth of this size to compete internationally, and there’s certainly no evidence that the existence of such banks is good for the economy. The only thing that’s certain is that banks this large provide a huge and looming risk. They are able to take any chance no matter how ridiculous, ignore any warning, reward their executives with a lavishness that would make Caligula blush, and at the end of the day come cap in hand, sure that the government will bail them out.

The solution that Johnson and Kwak propose is one that has been suggested by many others — make the banks smaller. Use anti-trust regulation to break up these enormous banks, and set new limits so that no bank ever again has such a stranglehold on our nation that it becomes immune to its own stupidity.

Paul Volcker seems the most willing to attack the question of size, through his “Volcker rule” on proprietary trading (which according to David Leonhardt, would primarily prevent investment-oriented firms from taking cheap money in the discount window), which included a size cap. He’s speaking in Washington on Tuesday, and he may hold the key to a lasting soution for financial reform that is more than window dressing meant to score political points.

Obviously, reducing the size of the greatest behemoths in the economy will run into major resistance from those behemoths. Reducing the size of the financial industry benefits perhaps every other sector, including the bottom line of the federal government. But the banksters probably feel they can bully politicians into supporting their interests, with the lure of campaign contributions and the time bomb of blowing up the recovery as a carrot and stick, respectively.

We don’t need a banking industry at its present size; it actually restricts productivity across the economy in exchange for fattening bonus checks and stock portfolios. This is a battle worth having, if the President really wants to force a “win-win dynamic” with Republicans.

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