As Congress appears poised to pass the most significant banking legislation since Dodd-Frank, there is little political will to actually reduce the future risk of another taxpayer bailout. Instead, Congress is set to roll back regulations on small and midsize banks, with the largest banks hoping their rollback will soon follow. While reduced regulations may help small banks, the biggest banks remain a systemic threat to the economy.
Wall Street has fully recovered, but Main Street hasn’t. The Great Recession pushed millions of working Americans out of the labor force, some of whom still haven’t returned. Although the headline unemployment rate has fallen from a peak of 10 percent during the recession to 4.1 percent this past January, that statistic ignores people who have given up looking for work. A different measure of people in their prime working years suggests that more than a million Americans are still on the sidelines.
Having managed the Troubled Asset Relief Program , or TARP, for both Presidents George W. Bush and Barack Obama, I absolutely believe the bailouts were the right thing to do. They helped prevent the Great Recession from spiraling out of control and becoming another Great Depression, which would have cost millions more Americans their jobs and savings. It is clear, however, that an unintended side effect of the bailouts was the short-circuiting of the market’s own mechanisms to regulate excessive risk-taking.
The free market should provide multiple layers of governance to force firms to learn from prior mistakes. Individual shareholders and their representatives on boards of directors are supposed to be the first line of defense. Their job is to hold management accountable.
A second line of defense should be institutional investors, such as asset management firms, pension plans and endowments. These institutions routinely use their market clout to drive change in corporate America by demanding, for example, more diversity and independence of directors. They should be acting decisively to make sure the excessive risk-taking that led to the Great Recession is not repeated. But they aren’t because they all got bailed out — management, shareholders, boards of directors, asset managers, pensions and endowments. Ten years later, they are enjoying record profits and share prices. What financial crisis?
Economists call this problem a “moral hazard”; if people know they are going to get bailed out, there is no incentive to prevent the same mistakes. They can keep rolling the dice, knowing the taxpayers will rescue them.
That is why bailouts must be followed by tough regulations to prevent the kind of excesses and risk-taking that led to the crisis in the first place. Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection Act in 2010 to strengthen our financial system, and while the measure did some good, Congress did not go far enough. The recovery was too fragile at the time to take the decisive action necessary to protect taxpayers from future bailouts. And unfortunately, Dodd-Frank also saddled many community banks, which are not systemically risky, with unnecessary regulations. In that sense, it actually gave the big banks an even larger competitive advantage.
The Federal Reserve Bank of Minneapolis spent the past two years analyzing how much risk large banks still pose to the U.S. economy — and what we can do about it. Our conclusion is that the largest banks are still too big to fail, and if we were to face another crisis, the taxpayers would again be on the hook. The most efficient way to protect taxpayers would be to force the largest banks — those with assets greater than $250 billion — to double their current levels of capital. This could be paired with reducing the regulatory burden on community banks to create a more level playing field.
I have met with numerous members of the House and Senate, Republicans and Democrats. Many understand that the largest banks are still too big to fail, because they are bigger and more concentrated than ever. Yet congressional action on this issue appears unlikely. Because of the bailouts, the free market will not hold Wall Street accountable. Who is going to look out for Main Street?
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