Senator's Proposal a Nudge, Not an Assault, on 'Too Big To Fail' Banks

The senators say creditors believe the government will rescue megabanks if they are about to fail. (AP Photos)

Senator's Proposal a Nudge, Not an Assault, on 'Too Big To Fail' Banks

New law would stipulate larger banks keep more cash on hand, but is slim on challenging Wall Street dominance

A new bipartisan bill introduced by Sen. Sherrod Brown (D-OH) and Sen. David Vitter (R-LA) on Wednesday is designed to curtail--though by no means end--the possibility of future taxpayer bailouts of Wall Street financial firms like the ones that followed the financial collapse in 2008.

Ostensibly the bill aims to make smaller, regional banks more competitive by putting large burdens on the nation's behemoth institutions, but it is not clear how much political traction the bill will receive, nor whether--if enacted--it would actually succeed in uprooting or fracturing the biggest banks.

Vitter and Brown explain the thinking behind the bill in a New York Times op-ed on Wednesday:

Today, the nation's four largest banks -- JPMorgan Chase, Bank of America, Citigroup and Wells Fargo -- are nearly $2 trillion larger than they were before the crisis, with a greater market share than ever. And the federal help continues -- not as direct bailouts, but in the form of an implicit government guarantee. The market knows that the government won't allow these institutions to fail.

The bill proposed by the two Senators seeks to rein in large banks--defined as those with more than $500 billion in assets-- not by breaking them up, but by raising capital requirements on a sliding scale so that larger banks would have to hold more assets in order to prevent a situation where over-leveraged "too big to fail" firms find themselves on the brink of collapse or insolvency.

As BusinessWeek explains, the law would demand "a 15 percent capital requirement for so-called megabanks as a way to reduce risk and remove the perception that they would get bailouts in a crisis. Midsize and regional banks would need to have 8 percent capital relative to assets and the bill is 'silent' on capital for institutions below $50 billion in assets."

Politicoadds:

Despite the duo's assertion that the legislation is not aimed at breaking up megabanks, industry leaders gathered at the National Press Club on Tuesday expressed concerns about the potentially negative impact the bill could have on the broader financial system.

Rob Nichols, president of the Financial Services Forum -- a group that represents CEOs of the large banks and financial services companies -- warned that the higher capital standards that Brown and Vitter are advocating could hurt the economy.

Despite the banking industry's predictable opposition, however, Sen. Brown argues that splintering the biggest banks would likely benefit, not hurt, the economy. As the Cleveland Plain Dealerreports:

The senators want the major banks to increase their own tangible equity so that shareholders, and not just taxpayers, take responsibility for their risky actions. They want the banks to have greater liquidity by holding more assets they can immediately turn into cash in a financial crisis. They say they want to keep Wall Street banks that enjoy government backing from gaming the financial system with credit derivatives and other risk-inflated schemes, which even JP Morgan Chase's own employees failed to catch until too late.

By extension, their bill could result in some banks spinning off non-banking financial divisions into new, non-banking companies that don't enjoy government protection. While not the goal of this legislation, that would not necessarily be bad, Brown said.

"When people spin off subsidiaries, it is more likely to create jobs," he said in an interview, citing the opinion of former Federal Reserve chairman Alan Greenspan and the experiences of the oil trusts 100 years ago. "If this causes the banks to begin to spin off various assets they have, you will find likely job creation, not the opposite."

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