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If a Financial Institution is Too Big to Fail, It's Just Too Big
The Obama administration's new proposals to expand the Federal oversight of the nation's financial institutions represent a fundamental departure from the "hands off" policies of the Bush years that allowed last fall's financial collapse. They are critically important to the long-term financial security of our economy and working families.
They also offer the opportunity for us to once again consider the overall structure of the financial services industry itself. Last fall's financial panic raises anew a long-running issue in American politics: how big should financial institutions be allowed to grow?
To most Americans the answer is clear: if a financial institution is too big to fail, it's just too big.
From Andrew Jackson to Williams Jennings Bryant to Teddy Roosevelt and FDR, the battle over size and power of banks and other financial institutions has been a theme that has run throughout American history. The reason is simple. The larger a financial institution becomes, the greater its power to control the lives and futures of ordinary Americans. Of course, that power is never demonstrated so graphically as in times of financial collapse, when the excesses of unregulated markets and supersized financial empires implode on the entire economy.
Elizabeth Warren, who chairs the panel appointed by Congress to oversee the bank bailout legislation, points out that the first "credit freeze" -- or American financial panic -- occurred in 1792, not long after the new country was founded. A credit collapse then occurred roughly every 15 years until the Great Depression, when at long last the Federal Government seriously intervened to regulate the private financial market.
The Federal Deposit Insurance Corporation (FDIC) was created to guarantee bank deposits, put a halt to "runs on banks," and specify bank reserve requirements. The Security and Exchange Commission regulated the stock market -- and greatly increased transparency. And the Glass-Steagall Act was passed to prevent banks from branching out into other speculative arenas that might endanger their solvency.
These three provisions -- coupled with Keynesian fiscal policy and more aggressive use of monetary tools by the Federal Reserve -- broke the every-15-year cycle and effectively prevented a nation-wide financial meltdown for the next half century.
But then, the deregulation of the Savings and Loan industry in the 1980s led to the failure of hundred of thrift institutions and the collapse of property values. As if that were not enough, the increasingly powerful financial sector then managed to convince Congress to repeal the Glass-Steagall Act during the 1990s.
The result has been massive consolidation of power by a few major financial institutions that have ranged far afield from banking into highly speculative activities of all sorts. Brokerage firms like Goldman Sachs and banks like Citibank have become indistinguishable. Massive portions of the credit market now exist outside of the oversight of any regulator.
Today, 45% of the banking market in the U.S. is dominated by Bank of America and Citibank. The rescue of companies like AIG was justified because its size, and because the interconnectedness of its financial transactions, made its failure pose a "systemic risk."
But the fact is, there is no good economic rationale for the massive size of today's financial institutions -- or for the massive growth of the financial sector in general.
Often, those who advocate allowing unlimited corporate growth argue for the advantages of economies of scale. But once you look at the actual functions of financial institutions in the economy these arguments fall flat.
There are really three useful economic functions served by financial service institutions:
First, they are supposed to aggregate and reinvest savings; second, they are intended to allocate risk; finally, they provide products that can increase convenience and efficiency.
Of course our financial institutions also provide the opportunity for a relatively small group of Wall Street insiders to place gigantic bets -- to gamble for stakes far higher than those available at the gaming tables of Las Vegas or Atlantic City. As far as I am concerned, gaming in Vegas has fine entertainment value, but providing a gigantic worldwide casino for the rich is not an economically vital core function for the world's financial markets.
None of the three true core functions of financial institutions requires the massive size that allows the domination of the market place. In fact, the monopoly power and threat of instability that comes with that size itself threatens our economy. As they grow, these private sector players wield far too much power -- hitherto mostly unregulated by democratic institutions -- and leave us all vulnerable to the bad decisions, excesses and mistakes of a small number of unaccountable decision-makers.
We don't need massive financial institutions to aggregate large sums of capital for major projects. The publicly-traded financial markets themselves provide the means of doing so through transparent markets structures rather than backroom decisions by giant financial firms or private hedge funds shielded from public view.
The true innovations in financial products that bring us more convenience -- like ATMs, electronic funds transfers, and online banking can be achieved just as easily through the Internet and Federal Reserve if we had thousands of banks, than it can with just a few large ones.
Far from allocating risk so that the overall economy is more secure, the giant firms that operate increasingly out of the public view have transferred risk from themselves to the taxpayers. The recent government bank subsidies make this clear. They have created bonus structures like those at AIG, that give huge payoffs if financial bets are successful and no down side if they fail. In fact, as we now see in the case of AIG and many other financial institutions, they apparently generate huge payoffs even when their bets precipitate the collapse of the entire economy.
They have created more and more derivatives and other exotic financial products because each time an underlying asset is sliced, diced and resold they harvest the "golden crumbs." Those crumbs are the fees that, taken together, allow them to siphon more and more money into an increasingly bloated financial sector from the pockets of people who actually create products and services in the real economy. This is one of chief reasons why all of the economic growth of the last eight years has gone to the top 2% of the population, and why the real income of average Americans has not increased since 1972. It is also one of the chief reasons why the economy has fallen off a cliff. As any Economics 101 student can tell you -- if potential customers don't have money in their pockets to buy products, economic growth comes to a crashing halt.
The financial sector has doubled in size over the last 14 years. Its percentage of the GDP has skyrocketed. This huge wealth transfer from the "real" economy to the world of finance has created a vicious cycle of increased credit dependency. If your family's real income isn't going up, but costs are, you try to borrow to stay afloat. That is one reason why private debt now equals 350% of the Gross Domestic Product -- the highest ever. The more debt that consumers owe to the shrinking number of big financial institutions, the greater the share of their shrinking or stagnant incomes is siphoned off to the finance sector -- and the cycle just gets worse.
It is clearly time to regulate the entire world of finance, as Secretary Geithner has proposed. It is also time to break up the Citibank's, Bank of America's, and AIG's of the world.
And it is time to shrink the entire financial sector. This last goal will require an end to the anything-goes "Dodge City" mentality that allows consumers to have their pockets picked by financial "products" like teaser-rate mortgages with prepayment penalties that guarantee the consumer pays more than meets the eye. It will require tight regulation of credit card interest rates and fees. It will require oversight of the "derivatives" and "credit-default-swap" markets.
Serious regulation will inevitably cut back on the flow of income from normal people to banks and the financial sector as a whole -- and that's something that is long overdue.
Robert Creamer is a long time political organizer and strategist and author of the recent book: Stand Up Straight: How Progressives Can Win, available on Amazon.com.
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BRING BACK GLASS STEGALL ACT OF 1933 IN VERBATIM, COMPLETELY REPEAL GRAMM LEACH BILEY ACT,IT RE CREATED THE TOO BIG TO FAIL DISASTER WE NOW FACE.
ALSO REPEAL COMMODITIES FUTURES MODERNIZATION ACT, IT CREATED THE ENRON LOOPHOLE THAT ALLOWS THES SAME TRANSACTIONS TO GO ON OFF THE BOOKS, LIKE A DISEASE FESTERING IN YOUR BONE MARROW THAT IF NEVER CHECKED COULD KILL YOU IN AN INSTANT.
THINK ABOUT IT. !!!
THIS WAS SUDDEN TO REGUALR PEOPLE BUT TO WALL STREET, THEY HAVE BEEN HEDGING THEIR BETS FOR YEARS IN ADVANCE OF COLLAPSE.
I have a degree in economics. De-regulation only released the greed and the power of corporations over the people to the point that they "raped" them financially over the last decade and you could not even seek help in the courts because the bankruptcy laws were changed. Recently, I noticed that my Citibank Sears card had gone from 9.99% to 23.23% interest rate and called the service center. What I found out was that back in January a notice had been slipped in about the change that I had not seen. So a card I had faithfully paid, doubled. The man on the other end of the line said it had happened to him too and he works for Citibank! So my only option was to close the account, pay the amount back at the 9.99% rate thankfully, but Citibank lost a decade customer and Sears lost a four decades (40 years) customer! Citibank is too big and needs to be broken up into smaller pieces. No bank should put our whole financial system in peril!!!
The thousands of corporate mergers that led to the current insolvent megacorps [AIG, Bank of America, Citigroup, Wells Fargo, Chase Morgan etc.] were a major cause of our economic crisis which is looking like a Great Depression. Merck has announced it will buy Shering-Plough after Pfizer previously announced its acquisition of Wyeth. Giant corporate mergers lead to large layoffs, larger corporate debt, and substantial reduction in economic competition which increases monopolization. If President Obama is really a spokesman for the people and not the boardrooms he will instruct his Administration Justice Department or FTC to file a suit to block Merck Pfizer in court. This will prevent the establishment of 2 more companies that are too big to fail. Any merger which may lessen competition is illegal under the Clayton Act.
But the U. S. [Federal Trade Commission and Justice Department] did NOTHING when Boeing monopolized the U S commercial aircraft market buying its only domestic competition, EXXON acquired Mobil becoming the largest corporation. Uncontested mergers cost millions of jobs, made billions for Wall Street and created today's unstable concentrated structure without objection by Clayton Act enforcement.. Instituting a substantial merger fee to compensate for harmful consolidation impacts and merger prohibition if acquirer has to borrow to finance it. U. S. Senate and House should form committees on corporate accountability nd a new federal agency regulating corporate accountability.. Without enforcement it our economy is doomed to sink into a far worse economic depression.
Excellent article. I couldn't agree more. So......why are we bailing them out? If they're too big, and in need of bailout(s), why haven't we taken the opportunity to put them in receivorship and break them into bite sized chunks.....................?
I know you lefties think we're already socialists, but don't jump off the high dive just yet. Guess what, GOVT HAS NO RIGHT TO TELL A BUSINESS HOW BIG IT CAN BE. Give Obama time, though. I'm sure he's got projects that will allow govt control of the entire economy. And we all know how efficient govt is.............
Government has EVERY right to tell a business everything! The business only exists as a contract including the state! Since the state is the one that determines whether a corporation can exist at all, it CERTAINLY has the right to tell it how big it can get!
Whatever happened to anti-trust laws?? The government BETTER be setting some serious limits and enforcing them. Too big to fail is just plain too big, period.
You statement is so wrong its not even funny. What you don't realize is that corporations HAVE NO RIGHTS! It is a privilege to be a corporation, not a right. They have no individual rights because, surprise, they are not individuals! The fact that the government (legislature, courts and executive) has turned a blind eye to this over the last 20 years is the problem. Government needs to start executing this control over corporations again.
ur statement is wrong, it should have the right to stop them form destroying our economy.
corps are citizens citizens cannot kill each off without penalty of law, why should corps be allowed
to destroy billons of lives with shady business practices and be allowed to raom our financial markets looking for prey unchecked.
oh and yes we all know how incompetent Republican governance is, every timethe dems get the govt workign for the people, the RNC tricks its way in and once again shows us all how bad people who do nto believe in government can be !
DOES IT NOT BOTHER YOU THAT THE BRITISH OWN MOST OF THE U.S. BANKING ??????????
WE FOUGHT THE WAR FOR INDEPENDENCE FOR WHAT ???
Forget the British, China is by far our biggest creditor (thanks to G W Bush) and is already attempting to influence US policy. China has a popultion of over 1.32 BILLION (or 1 of every 5 people in the world), the US has a population of 306 million, give or take, so we are in no potition to argue with them. And don't worry too much about the spanish speakers who don't know English, we may all be learning Chinese in the not too distant future.
Once upon a time, small was beautiful.
By the time any company gets to big to fail, it is too late to figure out that it is too big.
Economics of scale dilusions aside, it gets down to span of control being effective and the reality that NO executive control function can be so precient that it can't make a mistake with their crystal ball gazing. After all, that is why companies pay big bucks to execs, it is a gamble on their ability to have perfect foresight.
Spread the risk is the obligation government has, but what are the standards? 1% global market share, 10%, 5% national market share, %of GNP for net worth? -- there has to be a level playing field, the rules have to be clear or business can't function either.
One could argue that health care costs have gone whacked in proportion to overall growth is symptomatic of the same issue: too much private centralization. But then, governement isn't precient either on day to day management any more than private institutions ... so how can the rules be made sensible & fair to business practices but still not put too much control into government.
Is an issue that technology has enabled this centralization and generated the risk?
Too big to fail is too simple a rubric to go forward with; it is really a observation of a symptom that could lead to simple an ineffective solutions. Does anyone really understand root cause here on this
Years ago -the Bell Phone System got too big, so the govt broke it up into smaller ' baby bells '
That solved the problem. But the Reagan / Bush / GOP policy wanted deregulaton of Wall St & banks.
Reagan Bush , Greenspan liked it that way. So their corporate buddies could sell ' junk' securities and call them TRIPLE AAA. and go wild with greed and unethical practices.- that should have been illegal, but were not. Without those policies this meltdown could NEVER have gotten so massive.
The Reagan / Cheney / Bush legacy of greed, dishonesty, lack of ethics , lack of safe guards to inform investors what the were REALLY buying- I hope they all enjoy their ill gotten gains. It was a giant ponzi scheme of the first order- Not any different than Bernie Madoff, except they managed to damage our entire financial system as well as people all over the world. Bush & Co HAS TO testify UNDER OATH..We the people deserve to hear the whole dirty truth. Why are they above the law ??
have you noticed at& t buying up alltheir old businesses, everyone is at&t gain.
few if any baby bells left.
but now at&t is a conglomerate so they get around monopoly laws buy says ing residential servceis nottheir core business. even thought they control a majority of the market.
"To most Americans the answer is clear: if a financial institution is too big to fail, it's just too big."
Didn't these large businesses used to be called monopolies and weren't "busted" at some time in our past history. AIG and other large businesses should be broken up.
Too big to fail? So big it has to fail.
Thanks for this excellent article. I wish these statistics would show up more in the daily MSM on TV and in print. I would very much like to see some of these statistics graphed out in a comparative fashion e.g. the rise in financial services as a % of GNP graphed against the decrease in top end tax rates and the flatline of average income since Reagan. I proposed these types of question to Arianna today for the CNBC appearance on Tuesday. Maybe you could help her out with some graphs to show on Squawk Box using some of the stats in your column? The finance types who watch that show are mesmerized by graphs and familiar with all the variables from when they were in school learning econ, maybe that will shake one or two of them out of their me-first comas when they see the macro impact of the last 30 years.
CNBC - Squawk Box etc are ' imposters' Not at all helpful to the typical investor..who sadly, listened and invested on their ' advice. They had no clue about this disaster - or did not care..
Robert Creamer makes a good point if you pay attention to the part about FDIC, but he ignores one point to all this. He almost said it when he was talking about, "The Federal Deposit Insurance Corporation (FDIC) was created to guarantee bank deposits, put a halt to "runs on banks," and specify bank reserve requirements". He is trying to say that you dont spend more than you are worth or what we say something is worth!! You notice that he left out Fannie and Freddie who were backing these loans that would sooner or later be defaulted on.Remeber that off all these loans that were being made by Fannie and Freddie their board members were making bigger bonuses. These bonuses were paid on a percentage of loans made whether they were risky or not. 90 million in 6 years was paid out to one individual.Stop being side tracked by people that want you to ignore the actual money that was spent by the goverment and how they are bailing themselves out of trouble to stay in a job. We will never pay the money off that we are spending now because China and Japan cannot afford our debt for long!! Watch the news and you will see who is buying our debt. So if you dont want to be a communist country like China you better research a little bit better on your own and make your own decision without the help of the goverment!
A.I G. is not a bank- so we had NO control over it-since deregulation in the 1980's
We need to get control of these institutions asap.
they were given option of self regulation, and chose the weakest regulatory authority to oversee this huge behemoth bank. and no one batted an eye at the obvious impossible taks for a regulator with one insurance licensed person to regualte the king kong of insurance.
Fannie and Freddie weren't backing the subprimes, get your facts from a FACTUAL location!! The very definition of a subprime used to be that Fannie and Freddie wouldn't back it!
"To most Americans the answer is clear: if a financial institution is too big to fail, it's just too big."
I don't know why this vital point isn't being raised constantly.
And please add WAL-MART to the list. Its business activities give it disproportionate clout when it comes to our policies and trade balances, etc But more importantly, because it's also the country's largest employer, its fortunes have a direct and immediate impact on a segment of the population that is especially vulnerable to financial setbacks. I'm not convinced that the financial instutitions really were "too large to allow to fail," but believe that Wal-Mart is the premier example of a company that truly is too large for public safety.
Walmart is not a finacial institution!!! Are you wanting to bring the union to Walmart? Dont ruin the only cheap place to shop left!!!!
Walmart is driving out good businesses. All we get is junk from Walmart. I no longer shop there. And it's still hard to find something that isn't made in or shipped from China.
Folks deserve a decent living wage and benefits. I will pay a bit more to let them have that.
walmart encourages its employees to get public assistance since their offer few affordable health benefits given their payscale, walmart bad for american workers, good for cheap shoppers sometimes.
go figure.
Nicely written for someone that is try to sneak unions into Walmart and raise the prices of the products we buy. What is your purpose. Turn walmart into GM
How about turn Walmart into a business actually HELPING people!!
I knew it was not just the Left who thought this when I heard Rep. Phil Gingrey of Georgia (R) saying these insitutions need to be re-regulated. Gingrey! He said they should stick with what they do best not branch out into so many other services. So retail stays retail not branch out into financial services and insurance. Insurance stays just insurance not branch out into financial advisors and school insitutions.
The GOP policies are the ones who allowed Banks & insurance Co's to merge and sell ' junk ' securities & label them TRIPLE A. That was legal , based on the GOP policy. It all began with Reagan's policies of deregulation of banks & Wall St. Yes Dodd / Frank fell asleep on the job- but none of it could have happened without Reagan's policy deregulation which both Bush's continued.
Agreed! Too big to fail = too big to exist!
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