The latest call to break up the too-big-to-fail banks comes not from the pages of Mother Jones or an Occupy Wall Street pamphlet, but from a far more unlikely source: the Dallas Federal Reserve. Harvey Rosenblum, head of the Dallas Fed’s Research Department, used his 2011 annual report, released last week, to explain why TBTF banks are a drag on the economy. It’s a convincing case, especially coming from someone with four decades of experience as a regulator.

The report, titled Choosing the Road to Prosperity: Why We Must End Too Big to Fail — Now, relies heavily on automobile metaphors. Banks are the engines that drive the car that is our economy, capital is fuel, toxic loans are sludge, monetary policy are the cylinders, etc. And even if you find these metaphors cheesy, they provide an effective way of understanding the connections between the banking industry, monetary policy and economic growth.

Rosenblum argues that, by bailing out the TBTF banks in 2008, the federal government prevented capitalism from taking its course, and undermined Americans’ trust in our institutions.

Psychological effects of the bailout

“[The bailouts] left a residue of distrust for the government, the banking system, the Fed and capitalism itself. These psychological side effects of TBTF can’t be measured, but they’re too important to ignore because they affect economic behavior,” writes Rosenblum, under the subhed “Sludge on the Crankshaft.” “People disillusioned with capitalism aren’t as eager to engage in productive activities.”

There’s a useful rebuke to anyone telling the Occupy Wall Street people to “get a job.”

Dodd-Frank falls short

Rosenblum believes that Dodd-Frank falls short of its goals. “For all its bluster,” he writes, “Dodd-Frank leaves TBTF entrenched…huge institutions still dominate the industry — just as they did in 2008. In fact, the financial crisis increased concentration because some TBTF institutions acquired the assets of other troubled TBTF institutions.”

And these institutions maintain the same corporate cultures that they did before 2008, writes Rosenblum: they focus on short-term profits and fees, and rely on their lawyers and lobbyists to keep the government from getting between them and their gains. Because of this, Rosenblum makes it the official position of the Dallas Fed that “the ultimate solution for TBTF [is] breaking up the nation’s biggest banks in to smaller units.”

Breaking them up will ensure less systemic risk in the future, and restore Americans’ faith in capitalism, says Rosenblum. What if all regulators were willing to take stances so bold?

One graphic that stood out was this one below, which shows how assets have concentrated toward large banks over the last 40 years. The Top 5 banks’ share has increased from 17 percent of the industry’s assets to 52 percent — three-fold. And almost all of this has come at the expense of small banks; the 95 large- and medium-sized banks represented in grey have lost only a small percentage of their market share, while small banks’ market share has declined to a third of its 1970 level. Pretty astonishing stuff:

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