FORBES: An Unhappy Birthday For Dodd-Frank: The ‘Too Big To Fail’ Problem Gets Bigger

This is the second in an 11-part series on the failed promises of the Dodd-Frank financial reform package and the continued, dangerous imbalances in our financial system.

There were lots of heated debates before passage of Dodd-Frank, but no disagreement from anyone in the administration or Congress about one thing. The bill had to end the possibility that American taxpayers would ever again have to bail out a big bank because its failure would have a severe impact on the entire economy.
Some of us argued at the time that Dodd-Frank’s solution to the TBTF problem would never work in the real world. Others thought it would. But three years later, there is a growing consensus across ideological lines that TBTF is still very much with us.
Sandy Weill, the creator of the Citibank behemoth, now argues that banks are too big. Two other former Citibank chairmen, John Reed and Richard Parsons, agree that TBTF is a problem. So do columnists from George Will and Peggy Noonan to Gretchen Morgenson and Joe Klein. Fed Chair Ben Bernacke recently said, “TBTF is not solved and gone.” Fed Governors Tarullo, Fisher, Stein, Plosser, and Bullard have similarly said there are still banks that are too big. Cam Fine, CEO of the Independent Community Bankers of America, a trade association with 7,000 members, says, “Too-big-to-fail firms should be downsized and split up.”
Jeb Hensarling, the Republican Chair of the House Financial Services Committee, has pledged to “end the phenomenon of ‘too big to fail’ and reinstate market discipline.”
If the consensus building for solving TBTF is growing, so is the flood of money the megabanks are spending to lobby against any reform. Ironically, they can well afford to spend whatever it takes because they are bigger and currently more profitable than ever. The numbers do not lie. Our biggest banks are bigger now than they were in 2008, when the Troubled Asset Relief Program dedicated billions of taxpayer dollars to make sure they didn’t fail. In part, that has happened because the government forced the merging of Merrill Lynch, Washington Mutual, Bear Stearns, Countrywide, and Wachovia into the largest banks, making them even larger.
A recent analysis by Thomas Hoenig, vice chairman of the Federal Deposit Insurance Corporation, used international accounting standards (rather than the accounting methods used by the banks themselves) for derivatives and consolidated mortgage securitizations. The results are eye opening. JPMorgan Chase, Citibank and Bank of America have become the three largest banks in the world. Together with Wells Fargo, which has become the world’s sixth largest, assets of the four largest U.S. banks amount to an astonishing 97 percent of our 2012 gross domestic product.
Is that too big? For many of us, it is. But if you argue size is not the problem, the question you must then ask is, what would happen if any or all of them were in extreme financial trouble?
Many people, including some cited above, who are convinced that banks are too big, also believe they could be resolved without taxpayer money through some iteration of what the FDIC has done successfully in the past with smaller failing banks through the Orderly Liquidation Authority included in Dodd-Frank legislation.
There are three reasons I believe that would not happen. Let me state the first as a simple question: Given the complex interconnections among the world’s largest banks, is it likely that at a time of financial crisis only one of them would be in trouble?
Second, even if that were to happen, there is no precedent for resolving a megabank through the FDIC process. The largest financial institution ever resolved by the FDIC was Washington Mutual, which had assets of under $330 billion. It was essentially resolved by selling it to JPMorgan Chase. Who is going to take over JPMorgan Chase or Bank of America, each with assets of $2 trillion, if one of them goes bust?
Third, size is just part of the problem. Unlike WaMu, our megabanks have a vast web of international offices and connections. Citigroup alone has over 2,000 foreign subsidies. Lehman was much smaller, with approximately 80 subsidiaries to deal with. Yet its bankruptcy took over three years because of the difficulties in resolving across national borders.
The Financial Stability Board, which includes all of the G-20 major economies, was established to watch and comment on the state of the world’s financial system. It is the most authoritative source on the progress of resolving across national borders. In its April 2013 report the FSB said that international regulators still lack the power to impose losses on creditors and resolve banks without taxpayer bailouts. “”Few jurisdictions, “it said, “have equipped administrative authorities with the full set of powers to resolve banks.”
Eventually perhaps all of the necessary foreign governments will agree to some sort of resolution, but I for one am not going to hold my breath. In the meanwhile, the only possible scenario is this: A megabank gets in trouble. It is critically important to move fast, before other banks get infected. There are no possible buyers. Once again, political leaders are faced with a choice—watch the dominos fall and risk the entire financial system or step in with government funds.
Given where we are today, the question isn’t if it happens, but when.

________________________________________

This article is available online at:
http://www.forbes.com/sites/tedkaufman/2013/07/18/an-unhappy-birthday-for-dodd-frank-the-too-big-to-fail-problem-gets-bigger/