Bernie and big bank busting

I recently had a good discussion with some of my Hillary-leaning Facebook friends about financial regulation. In particular, about the idea of reducing the size of big banks.

Sanders' ideas on financial reform go beyond breaking up the big banks. But sticking with the to-big-to-fail problem, forcing large banks to downsize isn't at all "utopian," as one of my Facebook friends suggested. On the contrary, the authority is there now. Also under even-the-bipartisan Barack Obama. And unless Obama does one of his famous Bipartisan deals to do away with it, it will be on the books if even-the-pragmatist Hillary Clinton becomes President next January.

And: the federal regulators routinely nationalize banks that go into bankruptcy. Heck, that happened even when Reagan and the Bushes were President. I guess we could call that "expropriating the expropriators." But it's usually just thought of as the routine procedure for resolving such bankruptcies.

The Federal Reserve and the FDIC are currently requiring Bank of America, Bank of New York Mellon, JPMorgan Chase, State Street and Wells Fargo to submit new plans by October 1 to reduce their systemic risk. From the AFP report on the story (John Biers, US rejects 'living will' plans of five US bank giants Yahoo! News 04/13/2016):

The plans, required in the wake of the 2008 financial crisis, are supposed to demonstrate how the failure of a "systemically important" bank would not devastate the broader financial system.

"The goal to end too big to fail and protect the American taxpayer by ending bailouts remains just that: only a goal," said Thomas Hoenig, vice chairman of the FDIC, in a statement. ...

Also worrying, the banks have gotten bigger and more complex since 2008 and have "excessively high leverage," Hoenig said.

If one of the banking giants were to fail, the others 'would become suspect in their ability to withstand the shock," Hoenig said. "Too easily one failure could become a systemic crisis."

Failure to submit acceptable living wills by the five banks' October 1 deadline could result in higher capital requirements and other toughened standards, such as restrictions on bank operations.

Given that TBTF is officially considered a serious problem by the bank regulators, you also wouldn't need to be a Utopian to ask why they seem to be proceeding after the 2008 crash with "all deliberate speed," to use a historically notorious phrase.

Or, we could ask why those silly hippies at the Federal Reserve and the FDIC are worrying about the TBTF problem at all ... They're probably all a bunch of "BernieBros"!

The TBTF problem is a classic case of what people mean when people talk about "socialism for the rich, free enterprise for everybody else." (And Hillary supporters think anything that can be described as "socialism" is bad, right?) It means that there is a de facto guarantee from the federal government that it will rescue the institutions if they are on the verge of going bankrupt. And, under past practice, even without making the stockholders lose any significant part of their investments, which is what would happen in a proper bankruptcy. Part of what that means is that those institutions can borrow money at lower rates than their less-systemically-important competitors. That advantage, and the implicit federal guarantee, encourage excessive risk taking and gambling with depositors' money. People like David Brooks fret about the "moral hazard" of such behavior when it involves ordinary people buying homes.

That moral hazard for the TBTF banks is also part of what encouraged the wild growth of financial derviatives, of which credit default swaps were one of the less malign varieties. This is a major part of what is usually referred to as the "shadow banking" system, although the offshore havens (including onshore Delaware, Nevada and Utah) are certainly part of it. The massive use of mortgage-based securities (another type of financial derivative) poured gasoline on to the fire of the real estate bubble and the crooked mortgage racket in the 2000s. While the TBTF banks didn't initially drive that bubble with their own mortgage businesses - there are plenty other parts of the finance business beyond the TBTF banks that need better regulation - the mortgage-based securities were an essential part of the problem.

Also, nationalized banking systems have also been and are real-world phenomena. It would be much more sweeping, but also not Utopian, to argue that in the context of a fully nationalized banking system, TBTF wouldn't be the same kind of problem it is today. From that perspective, breaking up TBTF banks looks like a mild cosmetic solution.

It's also worth remembering that the Shrub Bush Administration allowed Lehman Brothers, whose collapse played a big role in the 2008 crash, to go under because it was not officially considered TBTF. (There were other factors in the decision but that was part of the justification.) So there's a real question about how sufficient the current definitions are.

The TBTF problem was also a huge factor in turning the Greek debt crisis of 2009 into a prolonged depression in the eurozone and a problem that may well destroy the euro. Large German and French banks had heavy exposure on Greek bonds. There is no eurozone-wide bank resolution mechanism. So those banks getting a major hit with a Greek default would have meant endangering German and French systemically-important giant banks. So Angela Merkel got the eurozone to deal with that problem with a *genuinely* utopian solution of solving the Greek over-indebtedness problem by forcing them to take on even larger amounts of debt. The result was "socialist" salvation for German and French banks and their stockholders, economic disaster on an epic scale for Greece.

Closer to home, the homeowners who had their homes repossessed in the wake of the massive mortgage scandal got basically zero relief from the federal government. Despite the Tea Party whining beginning in 2009 that the fedrul gubment was giving Those People help after they got caught in moral hazard on their mortgages, they got very close to no relief from even-the-liberal Obama Administration. But the regulators are still screwing around in 2015 with modest measures to limit the federal liability on the TBTF giants.