Can two senators end ‘too big to fail’?

Barry Ritholtz
Columnist May 10, 2013

Last month, an unlikely pair of senators — Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican — introduced a non-binding resolution calling for the end of the implicit subsidies that “too big to fail” (TBTF) banks enjoy.

The Senate voted 99-0 in support of the measure.

Ritholtz is chief investment officer of Ritholtz Wealth Management. He is the author of “Bailout Nation” and runs a finance blog, the Big Picture. View Archive

This month, they have pushed their ideas into actual legislation: They introduced a bill called the “Terminating Bailouts for Taxpayer Fairness (TBTF) Act of 2013.” This bipartisan legislation would help eliminate the government subsidies that put taxpayers at risk and also give the largest US banks an advantage over their smaller competitors.

Just how much of a subsidy are the banks receiving? An International Montetary Fund Working Paper quantified it as creating an 80 percent basis point advantage to TBTF banks. A 2012 FDIC study found similar advantages. The implicit government guarantee that these banks would not be allowed to fail allowed them to obtain credit at a more advantageous rate. Bloomberg calculated that this amounted to a taxpayer subsidy of $83 billion a year to the 10 largest U.S. banks, ranked by assets — and $64 billion to the five largest. At the request of Brown and Vitter, the Government Accounting Office is trying to more precisely quantify the annual subsidy to megabanks from the U.S. government.

In this column, I want to look at two broad issues: First, what does the legislation (TBTF Act, S. 798) purport to do? How would it affect the competitive landscape for community and regional banks? Could it prevent future megabank bailouts?

Second, has this left-right duo crafted a bill that, if it were to pass, could serve as a formula for for getting things done in a divided Congress?

Let’s begin with the broader strokes of the TBTF act. The bill’s appeal is its simplicity. It does not require complex formulas. Enforcement is simple and easily executed. There is no need for new regulatory apparatus that might one day become “captured” by its charges. Rather, it uses basic formulas to mandate adequate capital reserves. The legislation eliminates most opportunities for banker shenanigans, such as hiding liabilities off the balance sheet or in “side pockets.” It also treats all asset classes and liabilities equally – including derivatives.

The broad strokes of the TBFA Act:

●Mandates a flat 15 percent capital requirement for any institution with more than $500 billion in assets

●Does not rely on ratings agency grades

●Removes off-balance-sheet assets and liabilities as different classes — they are treated as if they are on the balance sheet

●Requires derivatives positions to be included in a bank’s consolidated assets

●Requires that the capital cushion a bank holds be liquid

(Note that these five elements are much stricter than Basel III regulatory requirements. Brown-Vitter renders it irrelevant to U.S. banks).

Who could be opposed to such a straightforward form of taxpayer protection and risk management? Start with the TBTF companies themselves. The largest U.S. banks — JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, Bank of America and Wells Fargo — meet the new TBTF criteria of $500 billion in assets. None of these companies is going to be happy about actually having to have real liquid reserves to hold against future losses.

Reduce their leverage and back out the government subsidies, and suddenly these banks look a whole lot less profitable. That won’t be good for the outsized bonuses that senior management has been paying themselves. Hence, it is no surprise that the American Bankers Association, the lobbying organization often associated with the largest banks, is also against this.

Then there are the rating agencies. The Brown Vitter TBTF act renders their ratings irrelevant, so far as the biggest banks are concerned. Note that rating agencies like Standard & Poor’s and Moody’s were the grand enablers of the credit crisis and financial collapse. Their ratings were a form of pay-for-play analyses, bought and paid for by Wall Street banks. Not surprisingly, Standard & Poor’s has already come out against the proposed legislation.

Brown Vitter has already gotten further than any other legislation that has sought to end TBTF. Why?

Simplicity: The most common complaint heard during the debate over Dodd-Frank was its complexity. Dodd-Frank mandated regulatory rulemaking from a patchwork of agencies requiring “10s of 1000s of pages” of new regulations.

The beauty of the TBTF Act is its simplicity — hard numbers for capital reserves. Banks must maintain a 15 percent capital reserve. For those people who complained that Dodd-Frank was too complex, let’s see how they like “the new simplicity.”

Broad ideological support: A diverse cross-section of parties has found that their interests align with this legislation.

Anyone who opposed the bank bailouts likes the ideas of adequate capital buffers. So, too, do those people who dislike broad regulatory complexity and the bureaucratic infrastructure it creates. Hence, support for the bill comes from a broad spectrum of political thought.

By removing competitive advantages megabanks have over smaller and regional community bankers, the bill is a straightforward support of industry competition. That appeals to libertarians and consumer advocates alike.

Splitting the bank lobby: Perhaps the most significant development has been among the banking lobby itself. Before Brown-Vitter TBTF, the industry responded to all proposed regulatory reform legislation in lockstep. The new proposal splits the industry cleanly in half, with the megabanks on one side and everyone else on the other.

Consider the Independent Community Bankers of America , which has more than 5,000 member banks with more than $2 trillion in deposits and assets. In a news release applauding the bill, the organization urged all community banks to join the association in advocating passage of the bil. Bill Loving, the ICBA’s president and chief executive of Pendleton Community Bank, added, “This legislation will reduce systemic risk, protect taxpayers and put our nation’s community banks on a competitively balanced playing field.”

Cleaving the bank lobby in two may give the bill a fighting chance of passing where prior legislative proposal had no chance.

Federal Deposit Insurance Corp. support: Also of note is the fact that the FDIC’s vice-chairman Thomas Hoenig, a longtime critic of TBTF banks, is in favor the legislation. The FDIC guarantees deposits when banks fail, and anything that reduces the risk of bank collapse garners its support.

~~~

The idea that two senators from opposite sides of the ideological spectrum can find common ground to attack a problem with a simple solution is novel in the Senate these days. If Brown and Vitter manage to end the subsidies to banks deemed “too big to fail,” they will have accomplished more than “merely” preventing the next financial crisis. They will have helped to create a blueprint for how to get things done in an era of partisan strife.

That is a worthy goal all Americans should be grateful for.

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