By Mike Konczal
Attorney General Eric Holder said something in Senate testimony that many had thought, but had never heard admitted at a high government level. "I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them," Holder said. Too big to fail, in other words, has become too big to jail. That's got lawmakers talking about breaking up the banks again, if only to ensure that our basic laws can be reasonably enforced.
The financial industry is taking note. Hamilton Place Strategies released a white paper last month arguing against breaking up the largest banks, arguing that they provide a useful, important role in the global finance economy.
Sen. Sherrod Brown was the co-author of the Brown-Kauffman amendment that would have broken up the banks, but failed to pass during Dodd-Frank. He is currently working with Senator David Vitter (R-La.) on a new bill to help combat the Too Big To Fail. This conversation is slightly edited for length.
Mike Konczal: Can you describe what would your Break Up the Banks bill does? Who would be subject to it, how would they be broken up, and what would be the timeframe?
Sherrod Brown: My legislation is called the SAFE Banking Act, also known as Brown-Kaufman, for the amendment my former colleague Ted Kaufman and I offered to the Dodd-Frank bill. The legislation would place sensible limits on the amount of debt that a single financial institution could take on relative to the entire productive economy. No bank could have non-deposit liabilities valued greater than two percent of U.S. GDP, and no investment bank could have non-deposit liabilities exceeding three percent of GDP. This would only affect the six largest megabanks, which would be given three years to comply by drawing up their own proposals to meet this goal.
Under my plan, the largest U.S. banks would have approximately $1.2 trillion in combined liabilities. The six biggest megabanks would be reduced from their current size of about 64 percent of U.S. GDP to about 34 percent of GDP, as they were in 2001. Finally, their funding would come from more stable sources, with about $3 of deposits for every $1 in volatile non-deposit funding.
MK: I want to walk through some of the criticism of breaking up the banks. One you hear all the time from industry is that our banks give us an international, competitive edge in finance. Especially our largest banks, who do more financial services than what small banks do.
If we break up the banks, we'll lose that, and we may lose it to other countries. What do you make of those arguments?
SB: I am not proposing that every bank be limited to $500 million in assets. As a result of my legislation, $2-trillion megabanks would be about $1.2 trillion. I have yet to hear why 20 super-regional banks couldn't do a better job than 11 megabanks that benefit from implicit guarantees from the federal government.
The biggest banks argue that only they have the capability to make $20 billion loans to multinational companies like Caterpillar. When the nation's biggest bank made the largest loan in history in 2011 -- a $20-billion loan to AT&T to take over T-Mobile -- it shared that loan with 11 other banks because $20 billion was equivalent to about 17 percent of the bank's Tier One Capital. The losses from that loan alone would have lowered the bank's leverage ratio by a full percentage point. That's too much exposure for a bank to have to a single company. Multi-billion dollar international manufacturers also tell me that they spread their billion-dollar lines of credit among 25 banks because they don't want too much exposure to just one bank.
MK: Another argument you hear is that the largest banks are big, but that they aren't anywhere near as big as the largest banks of other, developed, countries. If you take the top 5 banks of, say, Canada, they are significantly larger as a percentage of their respective economies than in the United States. Should this influence our thoughts on the matter?
SB: US megabanks are actually larger than they appear because the U.S. and Europe are on different accounting systems that change the way that derivatives exposures are calculated. Tom Hoenig has done groundbreaking work showing that the six largest U.S. banks are almost $4 trillion larger under international accounting standards. Instead of being 63 percent of GDP, they are actually about 102 percent of GDP -- making JPMorgan, Bank of America, and Citi the three largest banks in the world.
During the financial crisis of 2008, it was clear that banks that were oversized in relation to their home country's economy were more likely to receive a bailout. European banks are still dangerously undercapitalized and they have been trapped in a recurring cycle of bailouts and poor economic growth for the past several years. Canadian banks were no exception -- their biggest banks borrowed as much as $114 billion from the U.S. and Canadian governments. The CEO of TD Bank told his investors, "what are the chances that TD Bank is not going to be bailed out if it did something stupid?"
We should not repeat the mistakes that Japan made in the 1990s, when it was home to seven of the ten largest banks in the world. At that time, Japan was in the midst of a credit bubble that burst and sent the nation into a decade-long recession.
MK: How do financial regulatory agencies think about this proposal? FDIC, for instance, has said the size and scope of the largest financial firms makes resolution more difficult. But they also often handle bank failures through selling the failed bank to another bank. If you have many banks near the limit, and one fails, it might make managing the failure much more difficult for FDIC.
SB: Right now, members of the Federal Reserve are engaged in a vigorous debate about this idea. Richard Fisher told me that he likes my proposal. Governor Dan Tarullo, probably the nation's foremost expert on bank regulation, has said that the idea has some promise, and that it addresses the sources of volatile short-term funding that were at the center of the crisis, but remain unresolved. Federal Reserve Governor Jay Powell and New York Fed President Bill Dudley have each responded to Mr. Tarullo with their own ideas. I am encouraged that top policy makers are giving this issue so much attention.
MK: When this came up for a vote during Dodd-Frank, it received 33 votes, 3 of which were Republican votes. The Treasury department was said to be against this as well. How has the political evolution of this changed since then?
SB: While we came up short in 2010, I am talking to several of my Republican colleagues about taking various actions to address "Too Big to Fail." Some of my colleagues who voted against us at the time have told me that they would vote with us today.
People are reconsidering their stance for two reasons. They see that Wall Street megabanks are too big to manage and too complex to regulate. Scandals--LIBOR manipulation, money laundering, robo-signing, the "London Whale," -- have shown that these megabanks are out of control. Just last week, Attorney General Holder said that our megabanks are too big to prosecute. That wasn't his decision in isolation, but the result of counsel from the responsible agencies. And senators are hearing calls to limit the size and risk of Wall Street banks from some surprising places. When regulators like Dan Tarullo, Richard Fisher, and Tom Hoenig, and conservative thought leaders like Jon Huntsman, George Will, Peggy Noonan, and David Vitter, speak out about this issue, senators sit up and take notice.
MK: How do you see things working alongside the rest of financial reform? In particular, if you could bring on GOP support by removing some central parts of Dodd-Frank, would that be a worthwhile tradeoff?
SB: There are a lot of good things in Dodd-Frank -- from the new Consumer Financial Protection Bureau to regulating over-the-counter derivatives for the first time. As Governor Tarullo told the Senate Banking Committee, my proposal is complementary to Dodd-Frank because the challenges that it addresses -- size and volatile funding sources -- remain unresolved. One of the reasons that this work is so important to me is that it focuses on the Wall Street megabanks, and ensures that our community institutions do not end up as collateral damage.