IT HAS been eight years since the start of the Great Recession, and six years since the passage of Dodd-Frank, the landmark bill designed to protect the U.S. financial system from another disastrous buildup of risk. Yet the largest banks — the globally systemically important banks, or G-SIBs — are still huge. The top six G-SIBs in the United States held $9.7 trillion in assets last year, up from $7.2 trillion in 2006, according to Bloomberg News. That’s 63 percent of all bank assets.
And so it’s natural to hear, on the campaign trail and elsewhere, that they are still “too big to fail,” i.e., so gigantic that market participants, believing the government ultimately stands behind them, fund the institutions more cheaply than the risks on their books warrant. Worse, the argument goes, this is a self-fulfilling prophecy; despite Dodd-Frank’s regulations, a bailout would indeed be necessary in a crisis. The only solution is to break them up, says Democratic presidential candidate Sen. Bernie Sanders (I-Vt.), among others.
The problem with this view is that it is oversimplified. First, some banks — JPMorgan Chase, Bank of America and Wells Fargo — got bigger partly because they absorbed failing competitors during the crisis, at Washington’s urging. Three of the top six, Citigroup, Goldman Sachs and Morgan Stanley, are somewhat smaller than they used to be. Second, there has been real change under Dodd-Frank; under heavy pressure from the Federal Reserve and other regulators, all of the big six are far better capitalized — that is, able to cope with a crisis using their own resources — than they were before Dodd-Frank. In fact, the top banks face a stiff additonal capital demand from the Federal Reserve in 2017 that’s already forcing the biggest firm, JPMorgan Chase , to plan further shrinkage. Last year’s Federal Reserve “stress test” found that the top 31 banks, not just the biggest half-dozen, could withstand a global recession akin to the 2008 one without a federal bailout.
Last month, Standard & Poor’s, the credit rating agency, downgraded the bonds of the eight biggest banks, raising their cost of borrowing to reflect S&P’s view that their access to “extraordinary support” from government is “uncertain.” In other words, they are no longer too big to fail.
Obviously, S&P’s opinion isn’t definitive, because even with our recent experience of a global panic, no one can anticipate the psychological atmosphere of the next big crisis, which might indeed prompt the government to save a failing bank. Nevertheless, speaking about the banks as though nothing has changed is not only wrong, but may also distract from a more relevant issue: The post-Dodd-Frank crackdown on banks has caused riskier activity to “migrate” into the unregulated “shadow” sector consisting of hedge funds, private equity and the like. At the moment, such firms are financing a minor renaissance in “no-doc” mortgages, according to the Wall Street Journal. Former secretary of state Hillary Clinton’s financial reform plan focuses on that, whereas Mr. Sanders mainly cries “break ’em up.” Ms. Clinton’s approach is better targeted, if not more crowd-pleasing.