By Simon Johnson
At one level, it is good to see the Republican Senate leadership finally express clear positions on the financial industry and what we need in order to make it safer. At another level, what they are proposing is downright scary.
In a Senate floor speech yesterday, Senator Mitch McConnell (Senate Republican leader) said,
”The way to solve this problem is to let the people who make the mistakes pay for them. We won’t solve this problem until the biggest banks are allowed to fail.”
Do not be misled by this statement. Senator McConnell’s preferred approach is not to break up big banks; it’s to change nothing now and simply promise to let them fail in the future.
This proposal is dangerous, irresponsible, and makes no sense. The bankruptcy process simply cannot handle the failure of large complex global financial institutions – without causing the kind of worldwide panic that followed the collapse of Lehman and the rescue/resolution of AIG. This is exactly the lesson of September 2008.
If a huge financial institution were to reach the brink of bankruptcy, the choice again would be: collapse (for the world economy) or rescue (of the very bankers and creditors who are responsible for the mess). The point of the reforms now before us is to remove that choice, as far as possible, from the immediate future.
There is only one plausible way to ensure banks that are currently “too big to fail” can actually fail: Make them substantially smaller. This is necessary but not sufficient for financial stability – a point we make most forcefully in 13 Bankers, where we support a whole range of complementary measures (including more capital, very tight regulation of derivatives, and tough consumer protection), as well as a broader approach to breaking the political power of these banks.
And, at some level, the size point has already been taken on board by the administration. The second Volcker Rule, as announced in January, reads,
“Limit the Size- The President also announced a new proposal to limit the consolidation of our financial sector. The President’s proposal will place broader limits on the excessive growth of the market share of liabilities at the largest financial firms, to supplement existing caps on the market share of deposits.”
The hard size cap proposed – although somewhat vaguely specified – in this part of the Volcker Rule should be applied and tightened considerably in the Dodd bill now approaching the Senate floor.
You can do this with the Brown amendment, a version of which we should expect to see on the Senate floor. Or you may prefer the approach of the Kanjorski amendment, which is already included in the House legislation. Our position is that the Democrats should propose – and the White House should support the strongest versions possible, with low and hard size caps on banks. Force the Republicans to defend explicitly our biggest banks and how they operate – as Senator McConnell now appears willing to do. Take that to the polls in November.
You cannot responsibly propose what Senator McConnell is now putting forward: Do nothing and later on we will be tough – despite the fact that, at the key moment of decision, the consequences of being tough on a failed global megabank (and its creditors) would be catastrophic. This is the true road to disaster.