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Tuesday, April 20, 2010

Break Up the Banks

Do want to end "too big to fail"? How about breaking up the banks?

The FDIC is empowered by the Federal Deposit Insurance Act to use its judgment to set the target value of the DIF taking into account any economic factors that it deems appropriate, but must select a target value of not less than 1.15% of aggregate insured deposits but no greater than 1.50% of aggregate insured deposits. This standard has a very practical protection against being relaxed for political reasons. If the target value is increased to allow banks to become bigger, then the banks will have to pay higher assessments into the DIF. This has two benefits: greater reserves for possible resolutions, and, higher costs for banks which will temper their fervor for greater growth. By way of illustration, the current targeted value for the DIF is equal to one and 15 hundredths of one percent (1.15%) of total insured deposits, the Macey Rule would not allow any bank to have total liabilities in excess of 0.0575% of total insured deposits, or approximately, $3.096 billion.

The Macey plan would, in practice, lead to the dismantling of only about 3 percent of the nation's banks. But these banks do all of the risky trading. They hold 100% of the derivatives that remain on banks' balance sheets, 100% of the trading liabilities, and over 80% of all bank liabilities. This data is not surprising because banks that are too big to fail have a huge competitive advantage over their smaller rivals because the customers of the biggest banks know that the government will bail them out if they get into trouble.

Like Odysseus trying to sail past the deadly and seductive Sirens on his journey back to Ithaca after the Trojan War, the government must find a way to protect itself from succumbing to the temptation to bailout companies when they fail. Odysseus's well-known strategy was to order his crew to plug their ears with beeswax and then to bind him securely to the mast, and make sure that he remained bound to the mast until they were out of earshot of the Sirens' island home.

Bill Kristol said this was the sort of bold idea the Republicans should champion. Of course, this is easier said than done. If you think financial regulation is tough, try and break up a behemoth like Citigroup without sending the financial industry into total chaos.

1 comment:

AG said...

Pssh, liberals have been pushing this idea since the collapse. Good luck getting John Boehner to listen between lunches with Jamie Dimon. As for Obama, he'd never approve that as long as Larry Summers and Tim Geithner are advising him.