By Simon Johnson
The Brown-Kaufman SAFE Banking Amendment proposed a hard size cap on our largest banks, limiting their assets to a very small fraction of the size of our economy. The premise was simple – and could fit on a bumper sticker (or in a campaign flyer for November) – “too big to fail” is too big to exist.
But this proposal to modify the Dodd-Frank financial reform bill failed in the Senate in early May, by a vote of 33-61, with 27 Democrats voting against the idea. Since that time, Democratic supporters have been asking their representatives the obvious question: Why did you vote against Brown-Kaufman?
Interestingly, no senators yet have replied – at least on the record – that the power of the megabanks was too great to be overcome. Instead, there are three main arguments going the rounds.
First, some argue that the Brown-Kaufman would by itself not have completely solved all the problems that can cause our financial system to meltdown. As one senator put it in a recent letter, “[Brown-Kaufman] would not solve the problem of systemic risk and systemically important institutions in a comprehensive manner.”
Another senator claims in a recent email to a constituent, “The notion of “too big to fail” is not simply about size, but is more about risk, leverage and interconnectedness; in many instances, breaking up financial institutions is not the most effective way to curb risk.”
These are odd arguments, because no one ever claimed that limiting the size of our largest banks was sufficient for financial stability. Rather the argument was that this step was necessary – given the political power of these banks and their manifest ability to individually (and collectively) wreck great damage.
In addition, while the slogan “it’s all about interconnectedness” sounds fine at the level of sound bites, the harsh reality is that the very best technology available for measuring interconnectedness between financial institutions is still a long way from being ready to guide policy. If you are waiting for the government to get a firm grip on this concept and, for example, for the Federal Reserve to do something about it, you will wait a very long time.
Second, it is also claimed – for example by leading members of the administration (in private) – that Brown-Kaufman would somehow have led to job losses and lower tax revenue. This is also an odd claim, because the amendment had a three year phase in period, which would have provided ample time for the financial system to adjust.
Rich Trumka, President of the AFL-CIO, has waded in on that specific issue, in a detailed written exchange with one member of Congress that refutes the claims of likely job losses. As Trumka puts it,
“Moreover, it was the financial crisis and the reckless speculation of too big to fail financial institutions that caused 8 million working people to lose their jobs and huge drops in the stock market and losses to pension funds.”
The big potential distortion in our lending markets moving forward, as Trumka points out, is that “too big to fail” banks can borrow more cheaply than their competitors – because their creditors feel there is an additional level of implicit government guarantee available to the biggest banks, precisely because their failure would cause an unacceptable level of collateral damage.
Nothing in the market reaction since Dodd-Frank passed suggests that this perception – and this reality – has at all changed. Such a distorted system most likely leads to further financial excess – followed by crash and painful rounds of job loss.
Third, it is claimed that Brown-Kaufman would “affect the global competitiveness of US banks and could potentially undercut our banks’ ability to finance the largest companies worldwide.”
This is completely implausible. Brown-Kaufman would have reduced the size of precisely five large banks – and it would have reduced them to a size they last had a decade or so ago, when both the financial system and the nonfinancial part of the economy were much healthier. There is precisely zero evidence that the nonfinancial part of our economy would have been harmed.
Trumka sums it all up well, “By voting against the amendment, you voted to continue the status quo, to avoid addressing the problem of too big to fail institutions and to leave our economy at risk of another financial crisis precipitated by the failure of a systemically risky institution.”
An edited version of this post appeared this morning on the NYT.com’s Economix; it is used here with permission. If you wish to republish the entire entry, please contact the New York Times.