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Bank Regulation That Makes Sense

“Too Big To Fail” (TBTF) is the standard for socialized risk and privatized profits.  The biggest banks enjoy an implied bailout under Dodd-Frank regulations that give them a tremendous advantage over smaller banks.  The complex weave of financial innovations that are their signature is impossible for anyone to understand, making the risk we have taken on as taxpayers almost impossible to quantify.

What can be done about it?  Try TBTF – the “Terminating Bailouts for Taxpayer Fairness” Act of 2013.

This legislation, introduced by Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, cuts through the complexity, levels the playing field among banks, and ends “Too Big To Fail” once and for all.  What chance does it have?  Actually, a very good one because of some terrific politics.

James Stewart In 'It's A Wonderful Life'The Brown-Vitter Bill itself is a marvel of modern legislation in its simplicity.  The typical way banks are regulated is by requiring them to maintain capital on their books to back at least some of the loans and liabilities they have outstanding.  Under the international regulations known as “Basel III” (for the town that hosted the conference that created them) those assets have to be 8% of the total capital of the bank.  A hit bigger than that and it all falls apart like the Bailey Building and Loan Association nearly did in “It’s a Wonderful Life”.

If that doesn’t sound adequate, consider what makes up the capital requirements in today’s regulatory regime.  Capital can be just about anything, rated in classes for its soundness and liquidity (ability to be made into cash quickly).  It’s all up to the ratings agencies to assess things properly.

Brown-Vitter cuts through all this with some beautifully simple and strict requirements for banks with assets over $500B:

•    A flat 15 percent capital requirement for any institution with more than $500 billion in assets (8% for smaller banks)
•    No ratings agency grades – capital must be in liquid assets
•    No off-balance-sheet assets and liabilities as different classes — they are treated as if they are on the balance sheet
•    Derivatives positions to be included in a bank’s consolidated assets

These requirements will hit the biggest banks the hardest, namely JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, Bank of America and Wells Fargo.  They would no longer be in any danger of failing unless there was a terrible financial apocalypse – which would hit just about everyone and have to be dealt with by other means anyway.

There is a lot more to this, however.  By moving all the assets and liabilities onto the books, these banks will suddenly look a lot less profitable – despite the tremendous advantages they enjoy when borrowing money.  It’s a problem we’ve discussed here with respect to JP Morgan, a company whose investors are indeed starting to wonder about.  A little bit more transparency should raise the grumbling into a dull roar.

The beauty of this bill, however, is in the politics of it.  Before it was rolled out Brown and Vitter introduced a non-binding resolution calling for an end to “Too big to fail subsidies or funding advantage for Wall Street megabanks.”  It passed 99-0, putting the Senate on record that something should be done.

The great political advantage comes in how it neatly splits the lobbying efforts of smaller banks away from the big guns.  The Independent Community Bankers of America , with over 5,000 member banks holding  $2 trillion in assets, is fully on board.  They have urged all community banks to join the association in advocating passage of the bill saying it “Levels the playing field”.  The American Bankers Association, lobbyists for large banks, is firmly against Brown-Vitter.  That split is very important because it signifies a new regime for legislators.  The logical division between the excessively large banks with different rules than community banks is widening dramatically.

The odds of Brown-Vitter passing are hard to calculate right now, but the two senators from both parties have clearly laid the foundation for passage well.  Sadly, there is no companion bill in the US House yet, and getting a sponsor in another body can bring complications.

Right now, this is an elegantly simple bill that does indeed level the playing field between banks of various sizes and takes the taxpayer off the hook.  There is no better way to put an end to both socialized risk and excessive regulation all at once.

Despite the gridlock in the Senate, the Brown-Vitter TBTF Act has a good chance to pass.  It’s worth keeping the pressure on all of Congress, especially the House, to make this happen.

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11 thoughts on “Bank Regulation That Makes Sense

  1. I agree that this makes sense. Simple is good and we can be sure it will be followed. The best part of this is that it puts all assets and liabilities on the books which should have happened long ago. How it got the way it is I will never know except that there had to be a lot of politicians paid off. It is hard to justify higher capital requirements for the largest banks and that may not make it through but the rest is very obvious and yes, it should be done!

    • Thanks! I think the reason for having large banks carry more capital is that they can’t be bailed out like a smaller bank can, at least not without draining the treasury, so it has to be made less likely. In turns “Too big to fail” back onto the market.
      I’d like to know more about your feelings on the rest of the regulation. I know these bills are hard to read, but this one is short.

    • It could yet happen. Anything can happen. The politics is good – if nothing else, this might be the setup for bigger victories yet to come, even if this bill doesn’t make it.

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  3. The fact that they got the Senate to pass a resolution to engage this was an awesome idea. That creates a public commitment by Senators to deal with too big to fail which will turn create greater support for the bill in the Senate. Now they need to find supporters in the House to do that same thing. If the House can pass a resolution about this then they will be more likely to pass a bill.

    Though ideally the proponents should have tried to get a resolution through both chambers of Congress before drawing up the bill. That is because now the House may look at the specifics of the bill prior to voting on a resolution to deal with too big to fail. So the bill could impact the likelihood of a House resolution.

    This bill could do a lot to eliminate too big to fail. But I would prefer and explicit law stating that taxpayers won’t bail out those gigantic financial institutions again. I want the government to tell Wall Street in simple explicit terms that the risk they incur is their own and not the taxpayers.

    • Thanks for the comment! The problem with a law saying we won’t bail out is that it’s possible to imagine a scenario where everything fails and we should bail out banks. Even so, there’s no reason that the institution might remain but nearly everyone is gone – some of them to jail.
      The lack of action in the House is a serious problem, and it’s something I will be talking about in the next post (if indirectly). The politics there is simply poisonous.

      • Ok I actually wasn’t clear, I do agree that on some rare occasions it might be absolutely necessary to bail out banks. But I think that any bank which needs bailed out by the government needs disolved by the government in an orderly fashion. Basically if it comes down to it the government will step in an ensure that obligations are met in order to prevent systemic risk spreading to other institutions. Then the government would liquidate the bank and the government would get paid first with the proceeds. After that what ever is left can go to shareholders and such. But no bank should exist once it requires a bail out. The bank functionally failed and should not be given a second chance to invoke that risk upon the country again.

      • I am thinking about this, and you do have a point. It would mean that everyone associated with the bank has nothing to gain from excessive risks, which is not a bad way to go IHMO. I have long favored what I said before but it does give some out to investors and lower level employees. Dunno. Thanks!

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