Banks too big to fail? Break 'em up, Congress.

Congress shouldn't let financial institutions get large enough to wreck the financial system. But questions abound about whether the Feds can be honest regulators.

Roger L. Wollenberg/UPI
Federal Deposit Insurance Corporation Chair Sheila Bair and Gary Stern, president, Federal Reserve Bank of Minneapolis, testify before the Senate Banking, Housing and Urban Affairs Committee regarding financial institutions that have become considered "too big to fail" in May. Congress should take steps to break up hulking banks before they get big enough to threaten the financial system.

If a financial company is deemed “too big to fail,” the remedy seems simple: Break it up. Make the bank small enough that even if casino-type investments lead to crisis, it will not threaten the entire financial system. And don’t let any financial giant super-size in the future.

Financial reformers in Congress talk about avoiding using more taxpayer money for future bank rescues.

So far, though, neither the House nor the Senate reform bills propose radical steps to make giant banks immediately smaller.

“Congress is spending more time over organizational boxes – whether the Fed [Federal Reserve] or a ‘council of regulators’ or some other entity will oversee the financial system looking for systemic risk – than getting to the root remedies,” notes Robert Reich, an economist at the University of California, Berkeley, and former secretary of Labor. He proposes:

1. Resurrecting the Glass-Steagall Act, the Depression-era law prohibiting commercial bank-holding companies from owning investment banking firms or other more risky financial companies. It was repealed in 1999.

2. Applying antitrust laws to break up “the biggest banks that have undue market power.”

The strongest measure before Congress, proposed by Rep. Paul Kanjorski (D) of Pennsylvania, would empower a new Financial Services Oversight Council “to rein in and dismantle financial firms that are so large, inter-connected, or risky that their collapse would put at risk the entire American economic system, even if those firms currently appear to be well-capitalized and healthy,” states the congressman’s press release.

This measure passed the House Financial Services Committee Nov. 18 as an amendment to the Financial Stability Improvement Act, the bill negotiated by committee chairman Barney Frank. At this writing, Mr. Frank hoped to have a floor vote on this act the week of Dec. 7. If passed, the bill must be reconciled with a Senate financial reform bill.

Among some liberals, there’s skepticism that any body created by Congress will actually break up big banks. Glass-Steagall was often ignored as big banks, such as Citibank, grew and grew and grew. Their concern is that Congress is too hooked on the financial industry’s political campaign donations. The sums involved are huge.

For example, in the 2009-10 election cycle commercial banks alone have given so far $950,966 to House Financial Services Committee members, reports Securities and investment banking firms gave another $1.8 million. Frank has gotten $1.1 million; Mr. Kanjorski, $637,110.

Campaign contributors can “blackmail the system,” says James Galbraith, an economist at the University of Texas at Austin. The Kanjorski amendment, he notes, allows for judicial review of a breakup proposal, a step that could delay action for years with broad discovery requests, etc. A congressional staffer argues that a court could act only if it finds the measure “imposed in an arbitrary and capricious manner.”

Peter Morici, a University of Maryland economist, is even more skeptical: “Counting on the Senate and House to properly regulate banks is like putting Charles Manson [a notorious murderer] in charge of White House security.” Congress takes too much money from Wall Street, he says, to be considered “honest regulators.”

He proposes limiting the deposits an individual bank can pile up – perhaps a ceiling of 5 percent.

Also calling for limiting the size of financial firms: Former Fed chairmen Paul Volcker and Alan Greenspan.

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