the audit

Audit Notes: Too Big to Fail Edition

December 3, 2010

Kansas City Fed President Thomas Hoenig has a must-read op-ed in The New York Times on why too big to fail has to go. He gets at one of the big reasons why the American public is so irate and/or disillusioned these days, which is particularly relevant in the wake of the Fed disclosures of the last couple of days:

In spite of the public assistance required to sustain the industry, little has changed on Wall Street. Two years later, the largest firms are again operating with bonus and compensation schemes that reflect success, not the reality of recent failures. Contrast this with the hundreds of smaller banks and businesses that failed and the millions of people who lost their jobs during the Wall Street-fueled recession…

Last summer, Congress passed a law to reform our financial system. It offers the promise that in the future there will be no taxpayer-financed bailouts of investors or creditors. However, after this round of bailouts, the five largest financial institutions are 20 percent larger than they were before the crisis. They control $8.6 trillion in financial assets — the equivalent of nearly 60 percent of gross domestic product. Like it or not, these firms remain too big to fail.

Care to argue against this?

What can be done to remedy the situation? After the Great Depression and the passage of Glass-Steagall, the largest banks had to spin off certain risky activities, and this created smaller, safer banks. Taking similar actions today to reduce the scope and size of banks, combined with legislatively mandated debt-to-equity requirements, would restore the integrity of the financial system and enhance equity of access to credit for consumers and businesses. Studies show that most operational efficiencies are captured when financial firms are substantially smaller than the largest ones are today…

More financial firms — with none too big to fail — would mean less concentrated financial power, less concentrated risk and better access and service for American businesses and the public. Even if they were substantially smaller, the largest firms could continue to meet any global financial demand either directly or through syndication.

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— Mike Konczal (aka Rortybomb) riffs off Hoenig’s op-ed to make the point that the bailouts benefited giant financial corporations to the detriment of small-to-medium-sized ones.

If you’re too big to fail, you have regulators and taxpayers over a barrel. That shows up in the bailout numbers, and Konczal has a couple of charts that illustrate that well. With the FDIC debt-guarantee program, for instance, 75 percent of the bailout went to just six giant banks. The remainder got split up between the 14,225 others.

He quotes Raj Date:

Policy-makers, in effect, have decided to give to big firms, for very close to free, a strategic advantage that small banks have literally spent years and much effort cultivating….

Government rescue efforts, then, are unwittingly reinforcing the walls that prevent the market’s most efficient liability gatherers — small banks — from participating in the largest spread-generating asset businesses, from conforming mortgages to credit cards.

— Chris Hayes, subbing for Keith Olbermann, has a nice rundown of the foreclosure scandal and why it really matters. Hey, if millions of people getting kicked out of their homes won’t get Washington’s attention, surely the fact that their too-big-to-fail banks may have a solvency problem because of it will.


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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.