For years, many high-level economists and financial experts [20] have said that - unless we break up the giant banks - our economy will never recover, real reform will be blocked, and democracy and the rule of law will be corrupted.
The President of the Federal Reserve Bank of Dallas - Richard Fisher - has been one of those calling [21] for the breakup [22] of the giant, insolvent banks. But he has only done so in his private capacity ...
Until now.
This week, Fisher and the Dallas Fed's research director, executive vice president Harvey Rosneblum, sent out official communications from the Dallas Fed slamming the too big to fails, and calling for their immediate breakup.
Yves Smith points out [23]:
Ordinarily, pointing out that long-standing critic of too big to fail banks is still unhappy about them would not count as news. But the commentary of Dick Fisher, the head of the Dallas Fed, and that of his research director, executive vice president Harvey Rosneblum, is noteworthy because it stands in contrast to the emerging conventional wisdom inside the Beltway. I was told last week that the prevailing and accurate view of last year, that Dodd Frank didn’t go far enough, is being supplanted by the Jamie Dimon view that’s it’s too intrusive. Note that those aren’t actually inconsistent: effective bank regulation IS intrusive. Banker unhappiness would ordinarily be a good sign, but the crisis perps have taken to howling at any intrusion on their imperial right to profit. And the worst is that third parties take their kvetching seriously.
Are there any counter-arguments by the giant banks?
No. Instead, the head of the bank lobbying group - the American Bankers Association - used high school playground logic [24], saying (1) Fisher must be "addled from the Texas heat" and (2) other cars were going faster than I was, officer (i.e. other countries have more big banks).
Fisher sent out the following letter [25] in his official capacity:
Letter from the President
If you are running one of the “too-big-to-fail” (TBTF) banks—alternatively known as “systemically important financial institutions,” or SIFIs—I doubt you are going to like what you read in this annual report essay written by Harvey Rosenblum, the head of the Dallas Fed’s Research Department, a highly regarded Federal Reserve veteran of 40 years and the former president of the National Association for Business Economics.
Memory fades with the passage of time. Yet it is important to recall that it was in recognition of the precarious position in which the TBTF banks and SIFIs placed our economy in 2008 that the U.S. Congress passed into law the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank). While the act established a number of new macroprudential features to help promote financial stability, its overarching purpose, as stated unambiguously in its preamble, is ending TBTF.
However, Dodd–Frank does not eradicate TBTF. Indeed, it is our view at the Dallas Fed that it may actually perpetuate an already dangerous trend of increasing banking industry concentration. More than half of banking industry assets are on the books of just five institutions. The top 10 banks now account for 61 percent of commercial banking assets, substantially more than the 26 percent of only 20 years ago; their combined assets equate to half of our nation’s GDP. [See this [26] for a visual, graphic illustration.] Further, as Rosenblum argues in his essay, there are signs that Dodd–Frank’s complexity and opaqueness may even be working against the economic recovery. In addition to remaining a lingering threat to financial stability, these mega banks significantly hamper the Federal Reserve’s ability to properly conduct monetary policy.
They were a primary culprit in magnifying the financial crisis, and their presence continues to play an important role in prolonging our economic malaise. There are good reasons why this recovery has remained frustratingly slow compared with periods following previous recessions, and I believe it has very little to do with the Federal Reserve. Since the onset of the Great Recession, we have undertaken a number of initiatives—some orthodox, some not—to revive and kick-start the economy. As I like to say, we’ve filled the tank with plenty of cheap, high-octane gasoline. But as any mechanic can tell you, it takes more than just gas to propel a car.
The lackluster nature of the recovery is certainly the byproduct of the debt-infused boom that preceded the Great Recession, as is the excessive uncertainty surrounding the actions—or rather, inactions—of our fiscal authorities in Washington. But to borrow an analogy Rosenblum crafted, if there is sludge on the crankshaft—in the form of losses and bad loans on the balance sheets of the TBTF banks—then the bank-capital linkage that greases the engine of monetary policy does not function properly to drive the real economy. No amount of liquidity provided by the Federal Reserve can change this.
Perhaps the most damaging effect of propagating TBTF is the erosion of faith in American capitalism. Diverse groups ranging from the Occupy Wall Street movement to the Tea Party argue that government-assisted bailouts of reckless financial institutions are sociologically and politically offensive. [We've repeatedly noted that the Occupy and Tea Party movements have common ground in ending the bailouts and breaking up the giant banks [27].] From an economic perspective, these bailouts are certainly harmful to the efficient workings of the market.
I encourage you to read the following essay. The TBTF institutions that amplified and prolonged the recent financial crisis remain a hindrance to full economic recovery and to the very ideal of American capitalism.
It is imperative that we end TBTF. In my view, downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response. Only then can the process of “creative destruction”— which America has perfected and practiced with such effectiveness that it led our country to unprecedented economic achievement— work its wonders in the financial sector, just as it does elsewhere in our economy. Only then will we have a financial system fit and proper for serving as the lubricant for an economy as dynamic as that of the United States.
In the accompanying report [28], the Dallas Fed details how it views the idea of "too big to fail" as a severe perversion of capitalism:
As a nation, we face a distinct choice. We can perpetuate too big to fail, with its inequities and dangers, or we can end it. Eliminating TBTF won’t be easy, but the vitality of our capitalist system and the long-term prosperity it produces hang in the balance.
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Greed led innovative legal minds to push the boundaries of financial integrity with off-balance-sheet entities and other accounting expedients. Practices that weren’t necessarily illegal were certainly misleading—at least that’s the conclusion of many post crisis investigations. [And the government encouraged such behavior [29]. And see this [30].]
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Mammoth institutions were built on a foundation of leverage [which destabilizes the economy [31], but is still blessed by mainstream economists [32].]
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Make no mistake about it: A bailout is a failure, just with a different label.
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The machinery of monetary policy hasn’t worked well in the current recovery. The primary reason: TBTF financial institutions. Many of the biggest banks have sputtered, their balance sheets still clogged with toxic assets accumulated in the boom years.
In contrast, the nation’s smaller banks are in somewhat better shape by some measures. [And are therefore much better able to lend [33] to small Main Street businesses.] Before the financial crisis, most didn’t make big bets on mortgage-backed securities, derivatives and other highly risky assets whose value imploded. [The big banks no longer do very much traditional banking. Most of their business is from financial speculation. For example, less than 10% of Bank of America’s assets come from traditional banking deposits [34]. Instead, they are mainly engaged in financial speculation and derivatives. (and see this [35]).] Coming out of the crisis, the surviving small banks had healthier balance sheets. However, smaller banks comprise only one sixth of the banking system’s capacity and can’t provide the financial clout needed for a strong economic rebound.
The rationale for providing public funds to TBTF banks was preserving the
financial system and staving off an even worse recession. The episode had its downside because most Americans came away from the financial crisis believing that
economic policy favors the big and well connected. They saw a topsy-turvy world
that rewarded many of the largest financial institutions, banks and nonbanks alike, that lost risky bets and drove the economy into a ditch.
These events left a residue of distrust for the government, the banking system, the Fed and capitalism itself .... These psychological side effects of TBTF can’t be measured, but they’re too important to ignore because they affect economic behavior.
People disillusioned with capitalism aren’t as eager to engage in productive activities.
They’re likely to approach economic decisions with suspicion and cynicism,
shying away from the risk taking that drives entrepreneurial capitalism. The ebbing of
faith has added friction to an economy trying to regain cruising speed. [As we have noted for years, the economy cannot recover until trust is restored [36].]
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An unfortunate side effect of the government’s massive aid to TBTF banks has been an erosion of faith in American capitalism. Ordinary workers and consumers who might usually thank capitalism for their higher living standards have seen a perverse side of the system, where they see that normal rules of markets don’t apply to the rich, powerful and well-connected.
Here are some ways TBTF has violated basic tenets of a capitalist system:
Capitalism requires the freedom to succeed and the freedom to fail.
Hard work and good decisions should be rewarded. Perhaps more important, bad decisions should lead to failure—openly and publicly. Economist Allan Meltzer put it this way:“Capitalism without failure is like religion without sin.”
Capitalism requires government to enforce the rule of law. This requires maintaining a level playing field. The privatization of profits and socialization of losses is completely unacceptable. TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and powerful.
Capitalism requires businesses and individuals be held accountable for the consequences of their actions. Accountability is a key ingredient for maintaining public faith in the economic system.The perception—and the reality—is that virtually nobody has been punished or held account- able for their roles in the financial crisis.
The idea that some institutions are TBTF inexorably erodes the foundations of our market-based system of capitalism.
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The TBTF survivors of the financial crisis look a lot like they did in 2008. They maintain corporate cultures based on the short-term incentives of fees and bonuses derived from increased oligopoly power. They remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation. Just as important, their significant presence in dozens of states confers enormous political clout in their quest to refocus banking statutes and regulatory enforcement to their
advantage. [Two leading IMF officials, the former Vice President of the Dallas Federal Reserve [37], and the the head of the Federal Reserve Bank of Kansas City [38], Moody's chief economist [39] and many others have all said that the United States is controlled by an "oligarchy" or "oligopoly", and directly or indirectly said that the big banks and giant financial institutions are key players in that oligarchy.]
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A financial system composed of more banks, numerous enough to ensure
competition in funding businesses and households but none of them big enough
to put the overall economy in jeopardy, will give the United States a better chance
of navigating through future financial potholes and precipices. As this more
level playing field emerges, it will begin to restore our nation’s faith in the system of
market capitalism. [A study of 124 banking crises by the International Monetary Fund found [40] that propping banks which are only pretending to be solvent hurts the economy, and that breaking up the giant banks speeds recovery].