We need to really push back against the TBTF industry’s lobbying pitch that forcing them to shrink or break them up will cause them to be “uncompetitive”. This is a false notion and the only link they have for arguing against a requirement they reduce their size and scope, by imposing uneconomically high capital requirements or trust-busting.
If we fail to achieve this reduction in size and risk, the rest of the world will become uncompetitive given the lower cost of capital that the “implied government guarantees” will provide the. Ergo, these banks will further destabilize their non TBTF peers with their uneconomic pricing.
The House Financial Services Committee is now going to try and avoid real change by requiring that the industry “prefund” a failed bank clean-up fund. This is another avoidance of the reality of the problem. The mere acceptance that there are TBTF institutions IS the issue. Forcing the rest of the TBTF instituions to pay in advance rather than after doesn’t solve the problem, is unworkable and will cause greater probems given that:
– At the time one TBTF institution is in trouble there is a great liklihood that the liquidity of the others will be impaired;
– To force an institution that may manage its risks well to stand ready to pony up large percentages of its equity to support poorly managed competitors will support a race to zero in risk management as the good actor is forced to race to zero in his activities knowing that he is currently will lose market share to the poor practices of his peer and will later pay for the clean-up of his peer.
– Instead of playing this game we should place severly high capital requirements and charge deposit insurance (not based on deposits). This would force them to rethink their business plans. Then THEY could decide if it is better for their investors for them to be TBTF. Once determined they would either pay to play or sell off units (to the benefit of shareholders) and become more manageable, less risky and no longer TBTF.
– Also, we should demand that legislation spell out, in plain English, that the entire capital structure of a TBTF institution be wiped out, and its holding company held responsible as a source of strength, before taxpayers are exposed to a single dollar of loss.
Expanding on the “unleveled playing field”, as I wrote this week on New Deal 2.0:
Those who argue against a more proactive reduction in risk and size of TBTF institutions will, as always, revert to an argument that strikes a natural chord in every American’s heart: ‘Doing so would create an unleveled international playing field for our institutions relative to their international competitors.’ Level playing fields are a worthy goal, but this is not a relevant argument. Instead, this tired bromide must be resoundingly dismissed on several counts:
* Those countries with the largest banks as a percentage of GDP (Iceland, Ireland, Switzerland) demonstrated that a concentration of banking power can cause significant sovereign risk and tilt global economic playing fields away from that country.
* The likely breakups of ING, Lloyds and KBC suggest that it is we who seek to support an unlevel playing field where we subsidize our TBTF banks while other nations recognize the policy failures of moral hazard. If we continue down this path we will likely be at risk of violating international fair trade regimes.
* When the “unlevel playing field” argument is cited, keep in mind this reasoning supports the disadvantaging of 8000+ community banks relative to our largest banks, all in the name of protecting big banks from government- subsidized international competition.
* There is no longer any evidence that, beyond a cost of capital advantage that comes with implied government support, there are sustainable and tangible economies of scale arising from being the largest. The financial supermarket concept has been proven a failure. The only ones who benefit are the high-level executives.
* We must demand that our legislators no longer allow unelected officials at the independent Federal Reserve to sign international accords created by the TBTF banks through supra-national bodies like the Basel Committee.
* Are we to believe that if we did not have such large and globally dominant firms, US borrowers might be paying more that the 29% interest that several of the TBTF firms are now charging on their card accounts? Perhaps we should think about what advantage our population has gained as a result of our financial institutions being such a large part of our economy or being globally dominant.
* Since when did we accept a national strategy of following rather than leading? When we do what is right, others follow. As example, consider the bank secrecy havens — they made money for a bit. Now, even the Swiss and the Cayman authorities are coming around to our view.
* We are already at a disadvantage given that the largest foreign banks operate in the US without any tier one capital requirement and yet most large, foreign banks have not built a bricks and mortar presence here. Nobody screams about their undercapitalization nor has that undercapitalization caused deposits to migrate to foreign banks.
Also published at:
http://www.ritholtz.com/blog/2009/10/congress-and-tbtf-–-bring-in-the-bomb-squad/ (amazingly angry and thoughtful comments at this one)