IT is a prevailing myth in Washington: big bailouts are over for good. Never again, the line goes, could giant financial institutions imperil the nation’s economy.
This is nonsense, of course. Whatever regulators and lawmakers say, the Dodd-Frank financial overhaul lacks any guarantee that taxpayers won’t have to come to the rescue again.
So it was refreshing to hear a member of the Federal Reserve Board debunk the bailouts-are-gone theory last week.
The official was Richard W. Fisher, the president of theFederal Reserve Bank of Dallas and a longstanding truth-teller about too-big-to-fail banks. On Wednesday, in a speech in Washington, Mr. Fisher laid out a compelling proposal for shrinking financial giants in order to protect taxpayers. He suggested that megabanks be chopped into pieces, so that no one of them could endanger the financial system if it ran into trouble.
That may sound like a return to the Glass-Steagall Act, the Depression-era law that separated investment banking and commercial banking until it was dismantled in 1999. But Mr. Fisher’s plan is more sophisticated than Glass-Steagall, in that it recognizes how complex big financial institutions have become. Glass-Steagall concerned only old-school banking businesses, like making loans, and Wall Street businesses, like trading stocks. Today’s financial behemoths are in so many different businesses that a top-to-bottom restructuring is required.
Why? Mr. Fisher argued that megabanks not only threaten taxpayers with bailouts, but that their continuing failure to lend is also thwarting the Fed’s efforts to jump-start the economy by keeping interest rates low. “I submit that these institutions, as a result of their privileged status, exact an unfair tax upon the American people,” he told his audience. “Moreover, they interfere with the transmission of monetary policy and inhibit the advancement of our nation’s economic prosperity.”
Smaller institutions, by contrast, have continued to lend in the post-crisis years, especially to the kinds of modest-size businesses that create so many jobs across the country.According to figures compiled by Mr. Fisher’s colleagues at the Dallas Fed, community banks — defined as those with no more than $10 billion in assets — hold less than one-fifth of the nation’s banking assets. Nevertheless, they hold more than half of the industry’s small-business loans.
Huge banks must be restructured and their access to the safety net scaled back, Mr. Fisher said, because neither regulators nor market participants have proved effective in monitoring risks at these institutions.
The manic years before the credit crisis proved that regulators can’t police financial institutions appropriately. And while market discipline has worked to keep smaller institutions on the straight and narrow, it has been ineffective with megabanks, Mr. Fisher said. He noted, for example, that community banks typically have a few large shareholders scrutinizing the risks in their operations. But too-big-to-fail institutions, with millions of disparate shareholders, don’t benefit from this kind of concentrated policing mechanism.
Big banks’ creditors — like bond holders — don’t impose discipline, either. They know they will be protected by a taxpayer rescue should a large institution teeter.