Too Big to Fail

In 2008, the entire banking system of the USA came close to failing. Panic in the financial markets froze all sorts of troubled assets and this, in turn, froze many other kinds of assets. Banks lost liquidity and we got close to the edge of the cliff. We could not let the enormous money center banks like Citibank or Bank of America fail. To do so would have meant the collapse of the American and then the world economy. The result was the TARP program, an emergency bailout of the megabanks and the concurrent action by the Fed to pump liquidity back into the system.

In 2010, the Democrats and president Obama pushed through the Dodd/Frank law which was supposedly designed to reduce the chances that the USA would ever see another crisis like that in 2008. Dodd/Frank did a lot of things. It added a huge layer of regulations that banks now must comply with at great cost. It also added all sorts of social engineering requirements for the banking industry; for example, banks doing business with the government now must meet diversity requirements and have internal offices to monitor how well the banks are doing in achieving that diversity. What Dodd/Frank did not do, however, is make any attempt to end to problem of "too big to fail." Indeed, because the law makes it much more expensive to do business, Dodd/Frank actually makes it more likely that larger banks will grow at the expense of smaller banks that cannot afford all the additional regulatory costs as well as the big banks can. In other words, for all the oratory and self congratulations by the Democrats, they made the problem worse, not better.

It would not be that difficult to reduce the problem of too big to fail. Here is a five point plan that ought to accomplish just that.

1. Reinstate the old requirement that prohibited commercial banks from also owning investment banks. Let's take the risk of investment banking farther from the commercial deposits of the American public.

2. Set a maximum size for a bank of 3% of any state market. Any bank that was larger than this would have to break itself into pieces. This would add competition and reduce the effect of the failure of any one bank. in other words, the individual banks would no long be too big to fail.

3. Repeal Dodd/Frank and all of its extraneous rules that just make it harder for small banks to compete in the market.

4. Require reserves to be held for all sorts of banking instruments. for example, were someone to issue a collateral default swap, a reasonable reserve would need to be held by the issuer.

5. Set up a banking regulatory body whose approval would be needed before any new banking product could be offered to the market. The approval would be limited to setting (a)reserve requirements for the new product and (b) disclosures required prior to the issuance of that product.

This is a bare bones structure, but one which ought to go far towards ending too big to fail while also promoting competition in the banking industry.