(From the author of the book 13 Bankers, out tomorrow)
Some people at the top of the administration begin to understand that it makes both economic and political sense to impose binding constraints on our largest banks. But even the clearest thinking among them still has a problem - breaking up banks seems too much at odds with the way they saved these same banks in 2009. At best, this would be most awkward for the individuals involved on all sides.
"We'll achieve the same general goal by imposing capital requirements that increase with the size of the bank" (not an exact quote) is the administration's latest whispered idea, and in principle this has some appeal. If done properly, this could level the playing field - and therefore should be supported politically by small banks. By increasing the buffer against future losses, it would put in place greater protection for taxpayers against too big to fail (TBTF) institutions. And it would push TBTF firms to break up if they really have nothing better than cheap funding - based on implicit government subsidies – to support their continued existence.
But this "let's do it with capital requirements" proposal is deeply flawed and completely unacceptable. From different perspectives, Paul Volcker, Elizabeth Warren, and Ted Kaufman all agree, we cannot rely on our existing regulations (and regulators). We need new law.
Setting capital requirements involves a delegated decision, i.e., Congress indicates some parameters in general terms and the executive branch has to implement. The broad authority is in the hands of top people at the White House/Treasury, while the mind-numbing details fall to the regulators (subject to political pressure). So how do you write the capital requirements legislation that has the "end TBTF" outcome?
The bottom line is that you would have to trust the White House and myriad regulators. But neither have credibility on this front, as Senator Ted Kaufman insists. Given their track record, they might promise to raise capital enough, but once the moment of political attention is over, they'll likely just roll over for the big banks again.
Accommodating the interests of big firms – if that is what you want to do – is made all the more easy by the complexity of the issues involved. What is the level of capital requirements for the largest banks that would really level the playing field? Would 20 percent get it done? Why not 30% – which is more like the average of pre-1913 capital-asset ratios, i.e., before the era of modern bailouts? No one knows – and a good deal of assertive experimentation would be required.
On top of this, the international part of capital requirements runs through the Basel Committee, which (a) takes a long time, (b) is highly technical, and (c) is murky without any real accountability - i.e., by the time someone writes a front page WSJ article on what went wrong, it's 5 years too late. A key function of international organizations, not subject to disclosure like US public institutions or discovery like US private organizations (facing lawsuits), is to hide all kinds of dubious actions - there is by definition no sunlight. You can shred all the documents you want at an international organization; no one on the outside will ever get you for this.
Any approach that puts heavy emphasis on capital requirements comes down to trusting the Obama administration's economic team to be suitably resilient in the face of heavy pressure from big banks. But when these same people had the choice of being tough or nice to big failed bankers, by their own admission they went overboard on the niceness - no one on the board of directors of Citigroup was even embarrassed by what happened in early 2009. This tells us something about preferences, style and how our top officials see the world- whether you want to call this non-confrontational, highly deferential to the financial sector, or awe of Jamie Dimon.
How can any reasonable person trust the administration to get capital requirements right - i.e., so as to force TBTF banks to make themselves smaller - particularly when the Europeans have serious fiscal-financial problems, will want to paper over their own capital deficiencies, and are much more comfortable using implicit government guarantees to back banks than the US is (or should be)?
There is no substitute for new law here - just as Elizabeth Warren argues (and we discuss further in 13 Bankers). And the only law that will really deal with massive banks is law that effectively constrains their size - the point that Paul Volcker has been making and will likely reiterate tomorrow.