I wanted to highlight a great guest post on ending Too Big To Fail by my pal Bob Stein, senior economist at First Trust Advisors and a former Treasury official. After dismissing ideas that are extremely unlikely to happen, such as ending deposit insurance or politicians actually restraining themselves from bailing out troubled mega-institutions, Stein runs through the realistic alternatives:
1. More regulation.
In theory, one way is Dodd-Frank, the route favored by the Obama Administration and congressional Democrats: increase regulation, give regulators more discretion, and hope they do their jobs better than any set of regulators ever has. Essentially, this approach gives more power to the same kinds of people who missed the shenanigans of Bernie Madoff, MF Global, Stanford Financial, and Peregrine Financial. And that’s just in the past few years. Faith over experience.
2. Bust ‘em up.
Another route is to break up the big banks. As Alan Greenspan has said, “If they’re too big to fail, they’re too big.” The problem with this approach is that it eliminates the efficiencies provided by large banks and assumes there is no possible beneficial tradeoff for bank size above a certain level.
3. Way more capital.
A third option would be gradually, but substantially, raising capital requirements for banks considered TBTF. Not the small increase already scheduled under Dodd-Frank. Instead, lift capital requirements to at least 25% over the next twenty years and apply it to all assets, including government debt. (Yes, that means you, Uncle Sam.)
Institutions that don’t want to hold more capital wouldn’t have to; they’d simply have to stay small enough to fail. And in the meantime, we could dispense with the Dodd-Frank rulebook that tries to substitute the judgment of government regulators for what these firms really need, which is more equity to back up risk-taking.
Stein makes a lot of sense. I think a lot more highly of option #2 than he does, especially since I am not sure what those much ballyhooed efficiencies are, and I think there are political economy reasons for not having a lot concentrated economic power with a few players all telling Washington to do the same thing. I also think the Stein plan just takes too darn long. But I don’t know of any reason why #2 and #3 couldn’t be combined in some fashion. I have heard and written about #2, and look forward to exploring and hearing more about #3.