Financial Overhaul's Goal: End 'Too Big To Fail'

There's no shortage of demands from taxpayers to end bailouts like those for AIG, Citigroup and the other big banks.

One caller to NPR's Talk of the Nation asks, "Why can't we let the big banks fail and take their lumps?" Another says, "Wall Street and the bankers, they have the government bailing them out, like they're too big to fail. So, somebody's got to stick up for the little guy."

Just How Big Are U.S. Banks?

Only four American banks were among the world's 20 biggest in 2009 (ranked by total assets, in millions).

Bank Country Assets
1 Royal Bank of Scotland UK $3,500,950
2 Deutsche Bank Germany $3,065,307
3 Barclays Bank UK $2,992,682
4 BNP Paribas France $2,888,728
5 HSBC Holdings UK $2,418,033
6 Credit Agricole Group France $2,239,270
7 JPMorgan Chase & Co US $2,175,052
8 Mitsubishi UFJ Financial Group Japan $2,025,830
9 Citigroup US $1,938,470
10 UBS Switzerland $1,894,423
11 ING Bank Netherlands $1,853,393
12 Bank of America Corp US $1,817,943
13 Societe Generale France $1,572,721
14 Mizuho Financial Group Japan $1,494,960
15 Santander Central Hispano Spain $1,460,866
16 UniCredit Italy $1,455,270
17 ICBC China $1,427,685
18 Wells Fargo & Co US $1,309,639
19 Sumitomo Mitsui Financial Group Japan $1,219,544
20 China Construction Bank Corp China $1,105,471

Politicians are hitting the same notes.

"Never again should the American taxpayer be forced to write a check because of an implicit guarantee that the federal government will bail out a company when it collapses," says Christopher Dodd, the Connecticut Democrat who's chairman of the Senate Banking Committee.

Dodd's financial-overhaul bill hopes to end the practice of "too big to fail" by using a number of tools. Most important, it would penalize financial firms that become too big by requiring them to hold on to more capital.

"It's a buffer," explains economist Charles Calomiris of Columbia University, "It's something that absorbs loss. That's the main function of capital."

Many economists support this approach, including Harvard economist Ken Rogoff. But he's troubled that Congress may leave it to regulators to decide just how much capital big banks needs to set aside.

"I've spoken to a number of people in the financial industry who are very pleased that's it's all being left to the regulators, partly because they think they'll end up being less than if Congress were to force it in now," he says.

The proposal also sets out a new process for shutting down big failing firms. The Federal Reserve chairman, the Treasury Secretary and the head of the Federal Deposit Insurance Corp. would together decide when a huge firm should be put into bankruptcy. Their decision would be reviewed by a panel of three bankruptcy judges. If necessary, the FDIC would be in charge of breaking up the firm and selling its assets. Shareholders could be wiped out and creditors could also take a hit.

To protect taxpayers, the current financial-overhaul proposal would require big firms to create a permanent $50 billion fund that could be used by the FDIC to wind down big failing firms.

But Calomiris thinks that process could encourage bailouts, not end them. "Because it takes all of the apparent losses away from being borne by the taxpayers," he says, "it makes bailouts much more likely."

He says government officials will be much more likely to shut down troubled firms, if it appears that industry is paying the cost. But taxpayers will still bear indirect losses, because the big firms paying into the resolution fund will just pass on that cost to customers. Republicans, especially, share this concern.

Calomiris argues this could largely be resolved by taxing big banks to pay for bailouts after they occur rather than before. That would give bankers an incentive to lobby against unnecessary bailouts.

Rogoff, a former chief economist at the International Monetary Fund, says that idea is flawed. "The classic problem with taxing banks after the crisis is you can only tax the healthy ones. So, the sick ones don't have any money and the healthy ones are typically in trouble."

In Rogoff's view, the Dodd proposal isn't perfect but is headed in the right direction. But Simon Johnson, another former IMF chief economist, disagrees. Johnson, who's written a new book on the crisis called 13 Bankers, thinks more radical action is required. "If we can't cut our biggest firms down to a more reasonable size, a size at which they can fail, then we won't make any progress at all on this issue," he says.

Despite the industry's arguments, Johnson says there is no evidence that allowing banks to grow ever larger is good for the economy. "It's good for the bankers that run the banks, I know that. They get bigger bonuses and have more glorious empires. It does not benefit society and it shouldn't be allowed."

Johnson argues that if legislation does not cap the size of big banks, a repeat of the wrenching crisis we've just experienced is inevitable.

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