Break Up Big Banks? New Report on the 5 Questions to Ask

"A media campaign to vilify banks and bankers is not surprising; neither is populist support for radical steps after years of a media campaign. What is surprising, however, is the number of supposedly sophisticated commentators who allow themselves to be quoted in favor of something that is roughly equivalent to jumping off a cliff without knowing the depth of the water below." -- Peter Wallison, AEI Fellow & Financial Crisis Inquiry Commission member

In the latest Financial Services Outlook, American Enterprise Institute (AEI) scholar Peter Wallison poses five questions to those who advocate breaking up "big banks":

  1. Is 'Too Big To Fail' (TBTF) even real?  While it is a plausible theory that the largest banks are TBTF, it has never actually been demonstrated.  It has a basis in reality only because regulators have acted upon the theory in the past.  "Too big to fail" is shorthand for the more descriptive phrase "too big in the opinion of regulators to be allowed to fail."  Regulators belief that banks are TBTF does not make it so, and we do not know whether the system would have come apart had AIG and others been allowed to fail in 2008.
  3. What Size Makes a Firm Not Too Big to Fail?  No one - least of all the proponents of a breakup - seems to have any idea how small is sufficiently small to avoid TBTF distinction.  Dodd-Frank arbitrarily sets the limit at $50 billion in assets - a very low number.  Whether a financial institution is TBTF seems to rest on the judgment of an institutions' regulators, and their decisions will be affected by the conditions in the financial market at the time a failure occurs.  When the market is close to panic, regulators will be more likely to consider a marginal firm TBTF.  Furthermore, the TBTF designation also depends on the size of the economy; using an arbitrarily set number - like the one in Dodd-Frank - as a designation does no favors.
  5. Break Up Nonbanks?  The Financial Stability Oversight Council (FSOC), a new agency established under Dodd-Frank, is currently examining large non-bank firms (such as insurance companies, hedge funds, finance companies, securities firms, and private equity firms) to determine which are suitable to be considered "systemically important." If a firm receives such designation, it will be turned over to the Fed for stringent regulation - basically, nonbank firms will be subject to the same rules that apply to banking organizations.  Despite these measures, no one is calling for the break-up of these firms.
  7. What Would It Mean to Break Up the Biggest Banks? Thus far, no attempt has been made to assess the consequences of breaking up the biggest banks.  Such a decision could affect the globally active US firms' ability to operate financially, could affect the operation of the New York Clearinghouse, and could jeopardize the jobs of the millions employed by the largest banks.  Proponents have no answer to even the most basic questions on how such a move could affect the economy.
  9. What's Wrong with Dodd-Frank?  Proposals to break up the biggest banks reflect a conclusion that the reforms of the Dodd-Frank Act are not sufficient to protect against TBTF institutions.  Now that the proponents of the law are calling for the breakup of big banks and appear to think that Dodd-Frank is not sufficient to protect from TBTF, it is time to repeal the heavy regulatory measures of Dodd Frank that stifle growth.

A full copy of the report can be found here.

Peter Wallison served as a member of the Financial Crisis Inquiry Commission and is the Arthur F. Burns Fellow in Financial Policy Studies at AEI.  He can be reached at [email protected] or through [email protected] (202.419.5212).

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