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The Monitor's View

The weak spot in the financial reform bill

Bank size doesn't matter much in the financial reform bill. But it should. The Senate needs a debate, with Republican support, on whether to trust regulators to decide the size of the biggest banks.

By the Monitor's Editorial Board / April 27, 2010

Democrats are right. The Senate needs a full and rigorous debate on financial reform. But any debate must tackle one of the most critical issues not yet resolved from the 2007-09 crisis on Wall Street:

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Should big banks be left big?

President Obama says yes. He backs the main Democratic bill in the Senate that would rely largely on regulators to use a new set of enforcement tools to better manage the risks that financial institutions take. He’s less worried about megabanks, even if they are “too big to fail.”

Big banks are not inherently risky to the financial system, say Obama administration officials. Rather, the main issue is whether a bank has gone too far with bad loans, extended credit, or flimsy investments. If so, new tools would allow regulators to dismantle a big bank quickly without a taxpayer bailout. In addition, big banks would be required to keep more backup money on hand as a cushion for a crisis.

Even a smaller bank can bring down Wall Street, as the collapse of Lehman Brothers nearly did in 2007, if their risks are woven widely into other institutions. And besides, the United States needs big banks to be competitive in a world of big banks.

These are all good arguments for the Democratic bill, but such an approach relies heavily on two assumptions:

1. That future regulators will have the wisdom and experience to spot risks in banks before they implode, as investments in subprime mortgages did.

2. That future presidents and lawmakers will not go soft on enforcement because of campaign donations from the largest firms on Wall Street.

If past is prologue, those assumptions could be as risky as the actions taken by Wall Street. And that is why a long debate on financial reform is needed in the Senate – especially if it takes up an amendment offered by a small group of Democrats who want to place a strict cap on the size of financial firms.

Their amendment, known as the Safe Banking Act and sponsored by Sens. Sherrod Brown of Ohio and Ted Kaufman of Delaware, relies on the idea that “too big to fail is too big to exist.” It would cap the size of banks if they have deposits as high as 10 percent of the gross domestic product. It would also limit the size of their nondeposit assets. Any nonbank financial firm would have its liabilities limited to 3 percent of GDP.

This idea of a cap on bank size isn’t new. The 1970 Bank Holding Act gives such power to the Federal Reserve but it has been only loosely enforced. Under pressure from Congress, bank regulators have been reluctant to restrain the growth of banks.

The result? A large concentration of banking power – or half of the nation’s economic output – in just four firms: Bank of America, Wells Fargo, JPMorgan Chase, and Citigroup own half of the mortgages and issue most of the credit cards.