This is from a St. Louis Fed
of the following Dialogue:
St. Louis Fed economist William Emmons led the Dialogue, titled “Robo-signing,
the London Whale and Libor Rate-Rigging: Are the Largest Banks Too Complex for
Their Own Good?” Joining Emmons for the Q&A that followed were Mary Karr, senior
vice president and general counsel of the St. Louis Fed; Steven Manzari, senior
vice president of the New York Fed’s Complex Financial Institutions unit; and
Julie Stackhouse, senior vice president of Banking Supervision and Regulation at
the St. Louis Fed. See the videos and Emmons’ presentation slides at
Here's the last part of the write-up on dealing with the too big to fail problem:
Banks: Too Complex To Manage?, Central Banker, Winter 2012, FRB St. Louis:
... How To (Maybe) End “Too Big To Fail”
So, how will we deal with the megabanks? Emmons outlined two basic
approaches: radical and incremental. The radical approach involves structural
changes imposed on the banks themselves or the creation of a different legal
definition of what a bank is and what it can do. Radical proposals include:
- Reduce their complexity and size – Revive the 1933
Glass-Steagall Act (partially repealed by the 1999 Gramm-Leach-Bliley Act)
prohibiting combining commercial banking with investment banking or
insurance underwriting. Also, reduce their size by placing limits on banks’
assets or deposits. However, Emmons said this proposal likely wouldn’t
succeed because combining commercial and investment banking was not the main
source of problems; in fact, many of the “too-big-to-fail” institutions that
caused problems during the crisis would have been allowed to operate under
- Create “narrow banks” – Separate payments functions
from all other financial activities. Such a bank would take deposits and
make payments but not make loans except those that have very little default
risk. Emmons said this proposal wouldn’t be successful either because such
banks are not likely to be viable. Narrow banks likely would seek to make
riskier loans to improve their profitability, while non-narrow banks would
seek to enter the payments business in one way or another.
“In fact, we have chosen not to pursue radical approaches to solving the
‘too-big-to-fail’ problem,” he said. “Instead, we’re implementing
incremental—albeit significant—reforms of the existing legal, regulatory and
governance frameworks in which banks operate.” Meanwhile, bankers, regulators
and legislators won’t know whether the regulatory reform efforts will actually
work until they are actually used. Those efforts, which have sparked a lot of
profound debate throughout the financial industry, include:
- The 2010 Dodd-Frank Act – The law includes living wills
for orderly dissolution, capital requirements, stress tests, risk-based
assessments on deposit insurance, FDIC orderly liquidation authority, the
Volcker Rule and investor protections. “These are all pushing banks to be
more effective in internal discipline,” Emmons said.
- Basel III Accord – The third round of the Basel Accords
is looking to improve the quality of bank capital and make other changes
related to capital so that big banks demonstrate that they “have more skin
in the game,” Emmons said.
Emmons also offered another proposal: Make a strictly enforced “death
penalty” regime, a law mandating that any bank requiring government assistance
would be nationalized, with a plan to sell it back to new shareholders at some
point in the future. “The crux of the matter would be carrying through this
pledge to re-privatize the institution,” he said. “It should reduce the
incentives to take risk because the ‘death penalty’ is such a severe penalty
that it would act as a deterrent.” Emmons noted that TARP (the Troubled Asset
Relief Program) was a half-step in this direction, in which the federal
government took noncontrolling equity positions in megabanks—preferred instead
of common equity—and didn’t wipe out shareholders or management.
“It’s not so radical of a proposal because we did impose a ‘death penalty’ on
Fannie Mae and Freddie Mac: Their shareholders and management were wiped out.
General Motors and Chrysler were forced into bankruptcy, and AIG was effectively
nationalized,” he said.
“If this were to be the plan, we would need (to continue the metaphor) an
undertaker standing by—an institution that would be ready to exact this
discipline on the firms,” he said, pointing to other nations’ permanent
“sovereign wealth funds” that can take equity positions in firms.
The Jury Is Still Out
While investigations and lawsuits continue, regulations are written for new
laws, and the industry wrestles with proposed capital and other standards, the
question remains: Will any of this solve “too big to fail,” successfully rein in
systemic risk or prevent future “misbehaviors”? Simply put, we don’t know yet.
“I think it’s really important to realize that these are the early days in
terms of the reform efforts for the financial system, and many firms still have
to navigate a pretty complex set of changes to the regulatory landscape, how the
world is unfolding and how they’re going to generate profits,” Manzari said
during the Q&A portion.
Stackhouse noted that of the 400 or so regulations and rules required by the
Dodd-Frank Act, only about one-third are actually in place. “The financial
community, large banks in particular—those with over $50 billion in assets—have
a lot ahead of them,” she said. “The Dodd-Frank Act right now is the mechanism
on the table to deal with these very large firms. The jury is still out on how
that particular rule making will take place and how effective it will be.”
A strictly enforced "death penalty" sounds good to me, but I'd also like to
reduce the ability of large financial institutions to influence politicians and
regulators. The discussion does note that:
The revelations of recent controversies such as robo-signing, the London
Whale and Libor rate-rigging—explored in the “Big Bank Misbehaviors” sidebar
at the bottom—as well as other problems not mentioned here indicate that
something critical was lacking in the discipline of large, complex banks.
But the regulatory capture aspect of large banks isn't addressed.
I mostly wanted to highlight this slide from the presentation because it
answers a question I've been asking for a long time, how big do banks need to be
in order to reach the minimum efficient scale?
And from another slide, the size of the largest banks:
Some summary measures:
The conclusion seems obvious to me.