In an excerpt from my book, The Payoff, released on Monday, I wrote that during the April 2010 debate on whether to break up the too-big-to-fail banks, many Senators just couldn’t seem to comprehend the need to place a cap on bank size. Senator Judd Gregg (R-NH), for example, asked on the Senate floor: “What are we going to do next? Limit the size of McDonald’s?” That still seems like the biggest non sequitur I’ve ever heard. McDonald’s faces plenty of competition in the fast food market, and Big Macs hadn’t recently collapsed and destroyed $20 trillion in housing and financial wealth, throwing eight million Americans out of work. To me and many proponents of the SAFE Act, introduced by Senators Sherrod Brown (D-OH) and Ted Kaufman (D-DE), the idea of using size-and-leverage limits to preserve financial stability, as analogous to how we use size-and-market limits under antitrust law to prevent consumer harm, seemed obvious. After hearing the remarks of Senator Gregg and others who voted down the Brown-Kaufman amendment, I wrote:
Under antitrust law, we stop businesses from combining if it leads to market power and consumer harm. Why can’t Congress limit bank size to prevent financial instability and massive economic harm?
Yesterday, in a path-breaking speech by Federal Reserve Governor Daniel Tarullo, one of our leading bank regulators said essentially the same thing. According to Tarullo, in financial stability analysis, regulators need an “upper bound” on the organic growth of megabanks. Using reasoning from antitrust law, he said Dodd Frank lacks guidance comparable to section 2 of the Sherman Act, a restraint on monopolization:
[T]he absence in the financial stability area of the equivalent of the monopolization provision in Sherman Act Section 2 to complement the merger provisions in Clayton Act Section 7 creates an anomalous regulatory feature. It means that the current structure for financial stability regulation permits substantial increases in systemic risk by an institution, so long as it is generated from internal growth. To the extent that a growing systemic footprint increases perceptions of at least some residual too-big-to-fail quality in such a firm, notwithstanding the panoply of measures in Dodd-Frank and our regulations, there may be funding advantages for the firm, which reinforces the impulse to grow. There is, then, a case to be made for specifying an upper bound.
It’s difficult enough for regulators to decide whether to permit bank combinations, Tarullo said, because Dodd Frank requires them to balance the expected effect of the merger on “financial stability” with other factors – an imprecise undertaking. But beyond bank merger analysis, Dodd-Frank leaves a significant analytical hole, because it provides no guidance on upper limits on organic growth of already super-sized megabanks.
One of the difficulties in building out a financial stability analysis is the absence of an upper bound point of reference. There is no statutory basis for identifying a certain systemic footprint above which the risks to financial stability are not worth bearing compared to whatever possible benefits may be associated with the operation of the largest, most interconnected firms.
Accordingly, Tarullo suggested that Congress has more work to do. Otherwise, notwithstanding Dodd-Frank, our largest megabanks will continue to grow and enjoy lower borrowing costs due to the implicit government subsidy inherent in their too-big-to-fail status, thereby becoming a greater threat to financial stability. The idea Tarullo suggests for Congress to consider is exactly what the Brown-Kaufman amendment would have achieved (reintroduced in this Congress as the SAFE Act by Senator Brown): a limit on non-deposit liabilities used by our biggest banks and non-banks.
The idea along these lines that seems to have the most promise would limit the non-deposit liabilities of financial firms to a specified percentage of U.S. gross domestic product, as calculated on a lagged, averaged basis. In addition to the virtue of simplicity, this approach has the advantage of tying the limitation on growth of financial firms to the growth of the national economy and its capacity to absorb losses, as well as to the extent of a firm’s dependence on funding from sources other than the stable base of deposits. While Section 622 of Dodd-Frank contains a financial sector concentration limit, it is based on a somewhat awkward and potentially shifting metric of the aggregated consolidated liabilities of all “financial companies.”
It’s heartening to know that one of the leading bank regulators at the Federal Reserve has explained for all why Dodd-Frank would better preserve financial stability if it included the SAFE Act. No, Brown-Kaufman didn’t make sense for McDonald’s, but a growing number of thoughtful people believe it does make sense for megabanks.
THE PAYOFF: Why Wall