Solving Too Big to Fail Will Require Legislation

Here we are in the new year. Is it time yet for optimism?

The Great Recession of 2007-09 and the near financial collapse of 2008u2002are receding into history. The governments’ emergency bailout of the too-big-to-fail (TBTF) behemoths is being repaid. Massive government-subsidized profits and bonuses are returning to Wall Street.

On Dec. 11, shortly before the first session of the 111th Congress ended, House Financial Services Chairman Barney Frank (D-Mass.), in a herculean effort, secured House passage of the most sweeping financial regulatory reform bill since the Great Depression. The hard-fought Wall Street Reform and Consumer Protection Act of 2009 was a collaborative effort involving many different House committees and was refined by consideration of some 36 amendments on the House floor. Optimists might say that the massive fault lines in our financial regulatory structure are being repaired and strengthened, but former Fed chairman Paul Volcker would say we still have a long way to go.

Less clear, unfortunately, is whether this highly partisan Congress will come to grips with-and hopefully destroy-the malignancy that threatens our market-driven free enterprise system. While Senator Richard Shelby (R-Ala.) may not end up delivering the cure, he most certainly and graphically defined the disease when he told the Oxford Union that “too big to fail is an indefensible, flawed concept … clearly undemocratic-treating financial institutions and their creditors … pick[ing] winners and losers and privilege[ing] the large over the small …. By leading to bailoutu2002TBTF punishes innocent taxpayers.”

Bank Director readers could add that the divide between too-big-to-fail Wall Street institutions and too-small-to-save Main Street banks threaten our free market economy and democratic system.

A Washington insider not connected to any banking trade association, and whose father’s roots go back deep into community banking, brilliantly summed up the stakes in a private email. He wrote that “without changes in the law, it is quite possibly the end of the free enterprise banking system.”

Closer to home for community bankers is the FDIC’s failed bank list, which sees almost weekly additions. The other side of this coin is that coming out of the crisis, TBTF institutions have dramatically increased their market share with explicit and implicit government support. Of course Ken Lewis and his TBTF brethren are thankful for these government gifts that have socialized risks at taxpayer expense while privatizing gains. But the bailout has led to enormous public anger driven by a sense of unfairness, a 10% unemployment rate, and the colossal home foreclosure problem. Politicians are seeking to direct this anger onto others, which helps to explain the poisonous partisan divide in the Congress. The Federal Reserve is being used as a scapegoat and its independence is being threatened.

Now comes the hard part. Scaling back or eliminating TBTF will require new legislation. However flawed, HR 4173 moves the ball in the right direction-and that’s why it is being so bitterly opposed by those whose unrelenting march toward ever greater size, power, and profits would be thwarted by the legislation. The option of no legislation is a dangerous and unacceptable path on which the TBTF will become winners. Regrettably, in any legislation solving TBTF, the too-small-to-save will have to swallow some unnecessary medicine divined by the Democratically controlled White House and Congress.

No one assumes that financial regulatory restructuring reform legislation will have an easy path in the Senate. No one assumes that Senate Banking Chairman Christopher Dodd (D-Conn.) necessarilyu2002has the political will to aggressively attack TBTF, or that Senator Shelby will opt for legislation rather than confrontation. The alternative to legislation is an ever more concentrated economic and financial system buttressed by government support. Increasingly larger financial institutions will expand systemic risk.

FDIC Chairman Sheila Bair and Fed Chairman Ben Bernanke are committed to end TBTF. Chairman Bair has joined supporters of the Kanjorski amendment to HR 4173 in supporting size limitations, if all else fails. She has further noted that HR 4173 creates “an effective resolutions regime that will apply to large financial institutions … ensuring that we end the need for future bailouts.” HR 4173 is a promising foundation.

The time is at hand to lobby the Senate to pass legislation solving TBTF. Having no legislation would institutionalize the “indefensible” and “undemocratic” systemic risk TBTF institutions as the centerpieces of America’s economic future. This is unacceptable.

Guest columnist Kenneth A. Guenther is the former president of the Independent Community Bankers Association.