Not one to let a good crisis go to waste, Bank of America managed, in the dark days of 2008, to parlay its own insolvency and near collapse into attaining something it had long dreamed of: federal approval to bypass a national law that says that no bank may acquire another bank if it would end up holding more than 10 percent of the country's deposits.
For years, Bank of America had hovered on the 10 percent threshold. Its acquisition of Fleet Boston in 2004 put it over the line and should have been prohibited, but Bank of America, with the Federal Reserve's blessing, came up with a clever way to do the math. By counting all the deposits held in U.S. territories, like Guam and Puerto Rico, Bank of America inflated the national deposit total enough to limbo-dance its way under the bar. Similar contortions allowed it to acquire LaSalle Bank in 2007.
Fearing that it would be barred from buying up more banks, Bank of America began to lobby Congress to abolish the cap. Just a year before it helped bring the U.S. economy to its knees, Bank of America was circulating a position paper that characterized the size cap as "antiquated" and "conceptually flawed."
It didn't get very far with lawmakers. But what lobbying failed to accomplish was soon made possible by crisis. As the financial collapse unfolded, regulators made the astonishing decision that the way to deal with failing mega-banks was not to distribute their assets among smaller institutions, but to merge them with one another. Bank of America absorbed Countrywide and Merrill Lynch, and swelled to 12 percent of U.S. deposits. Wells Fargo crossed the 10 percent line when it took over Wachovia in 2008. JP Morgan Chase, fattened on Washington Mutual and Bear Sterns, emerged from the crisis holding 9 percent of our deposits.
Reestablishing a cap on the size of banks -- one small enough not only to limit mergers among giants in the future but to require an orderly break-up of the biggest banks -- ought to be a key pillar of financial reform. It's by no means the only policy needed to curtail systemic risk and rebuild a community-oriented financial system, but it is easily the best and most straightforward tool we have for constraining the concentration of banking power.
Dodd's financial reform bill lacks a hard cap on bank size, but an amendment put forward by Senator Sherrod Brown of Ohio would strictly limit the size of banks and, if enacted, entail breaking the country's largest banks into several pieces.
Brown's proposal fixes several flaws in the current deposit cap, which Congress adopted in 1994 as part of a sweeping deregulation bill that allowed banks to merge and expand across state borders with virtually no restrictions. The cap was added to the bill in order to appease public concerns that a few banks would become too large and powerful. (Those concerns proved well-founded. When the law passed, the top five banks together held 12 percent of U.S. deposits. A mere fifteen years later, the top five account for nearly 40 percent of deposits. See our charts for more detail.)
One problem with the current size limit is that it permits a bank to exceed the cap if it acquires a financial institution that is either in danger of going under or is organized as something other than a commercial bank, such as a savings and loan. These were the loopholes that allowed the Federal Reserve to escort Bank of America and Wells Fargo over the limit in 2008.
Another problem is that the cap applies only to deposits. As Simon Johnson, former chief economist of the International Monetary Fund, has noted, the big commercial banks have funded much of their recent growth not with deposits, but with various forms of wholesale financing. The same is true of investment banks, which do little in the way of basic consumer banking and thus can grow to a massive size without running afoul of the cap.
Most important, the current cap is simply too generous. It has already allowed banks to expand to dangerous proportions, exacting ever higher fees from consumers and limiting the flow of credit to small businesses. It could permit as few as ten banks to control our entire financial system.
Brown's amendment would prohibit banks from growing -- either on their own or through acquisitions -- to the point where their non-deposit liabilities (including off-balance sheet liabilities) amount to more than 3 percent of the country's gross domestic product.
Brown's cap does not allow any exceptions. It mandates that banks that are over the limit divest some of their assets or otherwise shrink. Its passage would entail downsizing at least five of the country's largest banks. Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase and Morgan Stanley, all of which now have non-deposit liabilities in the neighborhood of 5-8 percent of GDP, would each need to be split into two or three separate entities.
Opponents will undoubtedly characterize Brown's amendment as radical, but it is hardly so. It would simply return us to a industry configuration similar to the mid-1990s when banks were plenty large.
What is truly, and dangerously, radical is the notion that today's inflated banks, which not only wrecked the economy but used the crisis to expand their market power, should be allowed to set a new status quo for bank size.
As Senator Edward Kaufman of Delaware said in a speech earlier this month, "Given the high costs of our policy and regulatory failures, as well as the reckless behavior on Wall Street, why should those of us who propose going back to the proven statutory and regulatory ideas of the past bear the burden of proof? The burden of proof should be upon those who would only tinker at the edges of our current system of financial regulation."