Financial Reform Legislation Does Not Eliminate Too Big To Fail
The attempt to reconcile the House and Senate versions of financial reform legislation ran into trouble today when Scott Brown objected to a fee that was to be imposed on financial institutions to help pay for the cost of the legislation:
Congressional negotiators briefly reopened the conference proceedings on a sweeping financial regulatory bill on Tuesday after ... Senator Scott Brown, the Massachusetts Republican who had supported the Senate bill, said he would oppose the final version because it contained the tax on banks.However:
Conference negotiators voted to eliminate the proposed tax and adopted a new plan to pay the projected five-year, $20 billion cost of the legislation.There are more details on the compromise in the link above, but I want to focus on something I don't think is getting enough attention, something related to the bank fee that has now been eliminated.
This bill is not going to end the problem of too big to fail. If the banking system is threatened, then one way or the other it will be bailed out. The consequences to the economy would be too large to do otherwise. Thus, banks that are big enough to pose a systemic risk enjoy an advantage over other banks. Banks that pose a systemic risk will be assumed to be safer than other banks due to the implicit government guarantee. This gives large banks an advantage over smaller banks that do not, on their own, threaten the financial system if they fail.
In addition, the implicit guarantee gives large banks the incentive to take on too much risk, and this is a reason to regulate the amount of risk they can take (and I don't think the proposed legislation does enough in this regard).
So two things are needed. One is to ensure that the banks that operate under the implicit guarantee cannot take on excessive risk, and the other is to eliminate the advantage that the implicit guarantee gives to bigger banks.
One of the features of the proposed bank fee was that it only applied to large financial institutions, the smaller banks did not have to pay. While the fee wouldn't have been large enough to completely eliminate the advantage that the big banks enjoy, it would have helped. However, now that the fee has been eliminated, this will need to be accomplished in other ways. The compromise proposal does require a differential increase in FDIC insurance payments with bigger banks forced to pay more, but the difference is not sufficient to take away the advantage the big banks have over smaller banks. If anything, the compromise legislation that Senator Brown and others have insisted upon makes the problem worse. Thus, a big problem with the financial reform legislation is that it allows larger financial institutions to maintain the substantial competitive advantage they have had over their smaller rivals.
If financial reform legislation passes in its present form, it will have positive features. It creates a relatively strong and independent consumer financial products protection agency, it forces most derivatives to be either exchange traded or passed through clearinghouses -- though important exceptions remain -- and it provides regulators with resolution authority for large institutions in the shadow banking system. But overall, as with health care reform, the legislation is unsatisfactory in many ways -- it leaves much of the job yet to be done -- and it's not clear that Congress will have the will to follow through.
