Vaunted U.S. aim of ending too-big-to-fail could miss target
WASHINGTON -- bmckenna@globeandmail.com
At the heart of the pending overhaul of U.S. financial regulation is the notion that some banks are simply too vital to let fail. You can't let major banks go bust because their problems would cascade through the rest of the financial system. The legislation's backers like to say it ends too-big-to-fail.
That isn't quite so.
The bill, passed last week by the U.S. Senate, gives regulators powerful new tools to dictate what these companies can do, and then shuts them down when they get in trouble, without sticking taxpayers with the bill.
But it doesn't do away with the problem entirely. In some respects, the legislation formalizes a process to do what the U.S. government did during the worst of the financial crisis - the rescues of American International Group and Bear Stearns as well as the forced bailouts of large banks.
The bill's final passage is likely still more than a month away, and already critics argue it's all wrong.
Among the most vocal critics is Simon Johnson, former chief economist at the International Monetary Fund. Mr. Johnson, now a professor at the Massachusetts Institute of Technology and a fellow at the Washington-based Peterson Institute for International Economics, argues that the legislation makes the system vastly more dangerous than it was.
Instead of doing away with too-big-to-fail, the Senate bill embraces it, according to Mr. Johnson. Because of a special process proposed for the largest of banks, he says the government is tacitly acknowledging that certain banks are indeed too big to fail. The reforms essentially tell investors which institutions are backed by the government credit card. And that gives banks such as Goldman Sachs, JPMorgan Chase, Citibank and others an unfair advantage in borrowing money, amounting to a 60- to 80-basis-point interest rate subsidy, Mr. Johnson argued.
"These people know they are too big to fail. It's like giving them a lifetime exemption on speeding tickets."
The legislation "encourages them not to be careful" with their operations, he added.
During the months of debate leading to last week's vote, Mr. Johnson and others tried and failed to persuade lawmakers to limit the size of banks, based on the theory that if big banks are dangerous, then they shouldn't be allowed to get big. Their proposal would have capped banks at assets totalling 4 per cent of the U.S. economy.
Senators rejected the amendment.
Others worry that the United States is poised to over-regulate the financial services industry, potentially chocking off credit to businesses and consumers.
"The United States is well on its way to taking down the most innovative and successful financial system the world has ever known," Peter Wallison, a former U.S. Treasury official, argued in a commentary for the American Enterprise Institute.
The Canadian experience suggests the criticism may be overstated. Size alone doesn't make banks dangerous.
Canada's largest banks are extremely large relative to the size of the economy and yet they've remained sound through the worst of the financial crisis.
Canadian regulators have held up their system as a model for the rest of the world. They've argued that having fewer large and systemically important institutions makes it easier to monitor what they are up to, and then to crack down on risky behaviour.
Mr. Wallison may have a point: that more - and stricter - regulation can stifle financial innovation, and credit.
Yes, Canada's banks are sounder. But that may be because there's so much less competition. The downside is that banks have less incentive to work hard to get your business. And that means it's harder for Canadian consumers and businesses to get loans and generate economic activity.
In any post-crisis scenario, the trick is to figure out what went wrong, and then try to make sure it never happens again.
It will likely take years to sort out the full impact of the latest U.S. financial reforms.
One thing is clear: The problem is far more complicated than size alone.
