Today, banks can enjoy their explicit or implicit status as being TBTF potentially indefinitely. In contrast, the Minneapolis Plan puts a hard deadline on Treasury: Certify banks as no longer TBTF within five years, or else that bank will see dramatic increases in capital requirements. We believe the threat of these massive increases in capital will provide strong incentives for the largest banks to restructure themselves so that they are no longer systemically important.
Pointer from Mark Thoma. TBTF is, of course, too big to fail.
I endorse this approach. However, instead of the threat consisting of dramatic increases in capital requirements, I think that the threat ought to be to have the Treasury break up the banks. In effect, the government would be saying, “Either you break yourselves up, or we do the break-up for you.” I am confident that every large bank would come up with a divestment plan.
Keep in mind that the top financial institutions all grew through mergers and acquisitions. It is not as if any of them just naturally grew larger because of some unique ability to serve customers. As a result of these agglomerations, the largest institutions are too complex to be managed effectively. My guess is that breaking them into “smaller” units (I put smaller in quotes, because even after divestment these institutions would still be gigantic on a world historical scale) would not result in a large loss in total market value. It might very well result in an increase.
I should emphasize that smaller institutions are not necessarily less risky financially. But when they do fail, there are many feasible alternatives to bailouts. When a financial giant is about to fall, no Treasury Secretary can sleep at night unless there is a bailout.
A lot of the reason they are so large is from taking over smaller failing banks though and if it becomes problematic for them to do so the options for dealing with those smaller banks shrink. This is an endless struggle.
Canada has five TBTF banks that never have. A little more paternalistic but healthier.
There is no need to wait five years to increase capital requirements — define some threshold size on “financial institutions” ($50 billion in revenue?) (Citygroup reported $76 bln in 2015), and require 1% more capital to all such institutions. Then in the next year, down to $45 bln, with another 1% more (now 2%) required than those below the max. Keep increasing capital requirements for the “largest” firms, until some final “maximum size of failure” is achieved (maybe $10 bln).
Dodd-Frank can also be repealed once the capital increase requirement is enacted, and should be.
The financial services available to potential customers will be more variable, lower cost, and lower risk, than what is now available.
Nice job of picking the regulation you think will not increase costs to consumers due to the government, while picking the regulation you think does increase costs to consumers due the government.
I’d watch that whiplash if I were you.
Wouldn’t all the smaller banks just fail at the same time, thus necessitating a bailout? We know their lending behaviors are highly correlated and subject to the same systemic risk factors. To me this only makes sense if individual banks somehow become less-correlated.
This is a terrible approach that relies on the regulators being able to pre-emptively identify TBTF. The most likely outcome is that regulators would set a series of criteria that the banks would contort themselves around, and then went he next crisis came it would be shaped by those very contortions and now the largest banks all look TBTF again (or some other new term, critically entangled or whatnot) and there would be another bailout and new set of regulations.
If you want banks to be run more safely, give the managers a structural incentive.
One of the largest voices for safety in the airline industry are the pilots’ and flight attendants’ unions, because when a plane goes down, their members go down with it. It’s like the old joke about the pig’s and the chicken’s role in making breakfast: the hen is involved, but the pig is committed. Bank directors and executives need to be committed, but today they’re involved. Dick Fuld’s bank was actually allowed to fail, but even he still walked away with a net worth well into the tens of millions.
The more I think about it, the more I feel like the need for a bailout ought to be treated as being on par with cheating investors or embezzling company funds. If the government can prove beyond a reasonable doubt that you did not disclose relevant risks to investors and regulators, then you are guilty of fraud. You should do time and be barred from working in a regulated financial institution for a decade or two.
Please explain why large banks are so bad? If fact, I wonder if these ideas hurt consumers as the growth of large banks since 2010 has been ‘organic growth’ for the most part. (Yes, the growth from 1981 to 2009 was merger and buyout but that is true with a lot of industries.) My guess most people bank with somebody large because of some as simple as convenience (Our family does as Wells Fargo has the most ATMs in the area.) Unfortunately, banking is becoming more ‘utility’ like in my mind.
I know people love the idea of local banking but the Savings & Loans closed down for economic reasons.
Focusing on banks just shift the risk to something that isn’t a bank. See, e.g., AIG.
The answer has to be to stop pretending that a bank deposit is risk-free, and abolish the FDIC. The Federal Reserve can continue being the bank of last resort for illiquid but solvent banks. Then we can start talking about how to handle insolvent financial institutions without the threat of a bailout being part of the picture.