June 6, 2012

Sherrod Brown, a Democrat, represents Ohio in the U.S. Senate.

Two years ago — after the worst financial crisis in more than a half-century — one-third of the Senate proclaimed that “too big to fail” is simply too big.

A bipartisan group of 33 senators supported a proposal called the SAFE Banking Act, which I introduced with my former colleague, Ted Kaufman (D-Del.). This act would eliminate the taxpayer support enjoyed by the largest Wall Street banks — institutions that, by virtue of their size, could topple the entire U.S economy, should they fail.

Our amendment did not pass the Senate, but to judge from the numerous recent calls to limit the size and risk of Wall Street banks — calls that are coming not only from public squares but from boardrooms too — it’s clear that this commonsense idea is starting to take hold.

A few weeks ago, our nation’s largest bank revealed that it had lost $2 billion in a mere six weeks on trades that were supposedly intended to lessen its risk profile. Even at the best-managed firms, there are dangerous consequences of large, complex institutions undertaking large, complex activities. These companies are simply too big to manage, and they’re still too big to fail.

While the Dodd-Frank Wall Street Reform Act made some important changes, the government might once again be tempted to bail out a megabank in trouble.

When the Treasury Department decided which banks to rescue and which to let falter in the fall of 2008, it set the precedent that certain institutions are “too big to fail.” This status comes with an implicit guarantee from the federal government: As a result, ratings agencies give these megabanks a boost, and bondholders charge the banks less to borrow because they know that the government won’t let the institutions go under. Right now, about 20 of the nation’s largest banks can borrow money at a lower rate — ranging from 50 to 80 basis points by some estimates — than community banks can, thanks to this government guarantee.

Should the U.S. government give Wall Street banks an advantage over Ohio’s First National Bank of Sycamore? Supporters of truly free markets would say “no.” And yet our nation’s policies favor the trillion-dollar banks, fueling their risky activities.

This isn’t free-market economics. And it isn’t fair.

Government support also encourages megabanks to take more risks, by raising less equity and relying more on debt, than their community-bank competition. Research by Thomas Hoenig, a member of the Federal Deposit Insurance Corp.’s board of directors, shows that such banks need either to raise $300 billion in capital or to shrink their balance sheets by $5 trillion to meet the same standards that the market requires of community banks.

This is not how capitalism is supposed to work. It’s Wall Street welfare. And absent decisive action, U.S. taxpayers will continue to subsidize the largest banks.

That’s why I’ve reintroduced the SAFE Banking Act, which would end “too big to fail” once and for all by placing sensible size limits on our nation’s megabanks and ensuring that if they gamble, they have the resources to cover their losses. It would prevent any one bank from controlling more than 10 percent of federally insured deposits or assuming more than 10 percent of the U.S. financial sector’s liability. Under the bill, no bank could grow to more than 2 percent of the nation’s gross domestic product – with these limits reevaluated as the economy grows. Moreover, banks could not borrow more than $10 for every $1 of shareholder equity. These size limits would only affect the six largest Wall Street banks, who would have three years to downsize by selling assets or spinning off certain lines of business, as they see fit.

Megabanks should fund themselves the same way that community banks do: by attracting more capital and taking on less debt. Wall Street banks should use investors’ money — not U.S. taxpayers’ money — to make their bets.

It’s time for those who profess the virtues of the “free market” to put their equity where their mouth is. That means an end to the government guarantees that create a “heads I win, tails you lose” Wall Street culture. It means an end to picking winners and losers and an end to corporate welfare that gives trillion-dollar banks unfair advantages over regional and community banks. And it means preventing U.S. taxpayers from ever again being put in the position of having to bail out Wall Street.