By MyBankTracker  Fri Sep 7, 2012

Bloomberg Op-Ed: We’ve Ended Too-Big-To-Fail (You Just Didn’t Realize It)

Philip Swagel, a professor of public policy, penned an op-ed on Bloomberg explaining why breaking up the big banks would actually harm the American economy. His argument trots out the well-worn line of reasoning that big multinational firms need big investment banks to supply them with the astronomically large lines of credit that they need in order to function. There’s a certain logic to it until you realize that it’s not as if the United States’ economy was in the stone age until Glass-Steagall was repealed.

The novel (and perhaps naive) point that Swagel brings up to defend his argument is that Dodd-Frank successfully did away with too-big-to-fail banking. It is rare that you see someone who seems happy with the banking industry in its current state point to Dodd-Frank as an example of effective regulation — typically fans of the banking industry think Dodd-Frank is burdensome but ultimately ineffective.

His words:

Too-big-to-fail is a serious issue, but there has been more progress on this front than is widely understood. The orderly liquidation authority in the 2010 Dodd-Frank financial-reform law means that large banks can and will be allowed to fail in the future. Dodd-Frank allows the Federal Deposit Insurance Corp. to keep a failing bank running, but shareholders will be wiped out and bondholders, not taxpayers, will cover any government losses.

The law prohibits bondholders from receiving a taxpayer bailout and instead requires them to take “haircuts.” This means that investors thinking of providing funding to a risky bank know in advance that they will take losses if things go bad. This reverses the previous advantage of large banks in obtaining low-cost funding from investors who expected to be made whole from a government bailout.

What Swagel, who has the best last name of any public policy professor, ever, doesn’t seem to take into account, is that “orderly bank liquidation” is basically like doublespeak. Whatever might happen in the coming years to make Bank of America, Citibank or J.P. Morgan Chase fail will likely strike all three of them to some degree.

A monoculture is more susceptible to a devastating plague than a diverse ecosystem. When banking power is concentrated in the hands of the few, as it has come to be these days, the whole economy is always at risk, for the fact that one bank doesn’t go down quietly — it usually brings others with it.

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  • Sally G

    Well, it is good that we have some plan in place for the next disaster—but I agree that it is not enough, monoculture is always more susceptible to systemic problems than diversity.
    As I see it, Dodd-Frank is a start, not the desired finished regulatory system.