Bank regulation that makes sense

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“Too Big To Fail” (TBTF) is the standard for socialized risk and privatized profits.  The biggest banks enjoy an implied bailout under Dodd-Frank regulations that give them a tremendous advantage over smaller banks.  The complex weave of financial innovations that are their signature is impossible for anyone to understand, making the risk we have taken on as taxpayers almost impossible to quantify.

What can be done about it?  Try TBTF – the “Terminating Bailouts for Taxpayer Fairness” Act of 2013.

This legislation, introduced by Sherrod Brown, an Ohio Democrat, and David Vitter, a Louisiana Republican, cuts through the complexity, levels the playing field among banks, and ends “Too Big To Fail” once and for all.  What chance does it have?  Actually, a very good one because of some terrific politics.

The Brown-Vitter Bill itself is a marvel of modern legislation in its simplicity.  The typical way banks are regulated is by requiring them to maintain capital on their books to back at least some of the loans and liabilities they have outstanding.  Under the international regulations known as “Basel III” (for the town that hosted the conference that created them) those assets have to be 8% of the total capital of the bank.  A hit bigger than that and it all falls apart like the Bailey Building and Loan Association nearly did in “It’s a Wonderful Life”.

If that doesn’t sound adequate, consider what makes up the capital requirements in today’s regulatory regime.  Capital can be just about anything, rated in classes for its soundness and liquidity (ability to be made into cash quickly).  It’s all up to the ratings agencies to assess things properly.

Brown-Vitter cuts through all this with some beautifully simple and strict requirements for banks with assets over $500B:

  • A flat 15 percent capital requirement for any institution with more than $500 billion in assets (8% for smaller banks)
  • No ratings agency grades – capital must be in liquid assets
  • No off-balance-sheet assets and liabilities as different classes — they are treated as if they are on the balance sheet
  • Derivatives positions to be included in a bank’s consolidated assets

These requirements will hit the biggest banks the hardest, namely JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, Bank of America and Wells Fargo.  They would no longer be in any danger of failing unless there was a terrible financial apocalypse – which would hit just about everyone and have to be dealt with by other means anyway.

There is a lot more to this, however.  By moving all the assets and liabilities onto the books, these banks will suddenly look a lot less profitable – despite the tremendous advantages they enjoy when borrowing money.  It’s a problem we’ve discussed here with respect to JP Morgan, a company whose investors are indeed starting to wonder about.  A little bit more transparency should raise the grumbling into a dull roar.

The beauty of this bill, however, is in the politics of it.  Before it was rolled out Brown and Vitter introduced a non-binding resolution calling for an end to “Too big to fail subsidies or funding advantage for Wall Street megabanks.”  It passed 99-0, putting the Senate on record that something should be done.

The great political advantage comes in how it neatly splits the lobbying efforts ofsmaller banks away from the big guns.  The Independent Community Bankers of America , with over 5,000 member banks holding  $2 trillion in assets, is fully on board.  They have urged all community banks to join the association in advocating passage of the bill saying it “Levels the playing field”.  The American Bankers Association, lobbyists for large banks, is firmly against Brown-Vitter.  That split is very important because it signifies a new regime for legislators.  The logical division between the excessively large banks with different rules than community banks is widening dramatically.

The odds of Brown-Vitter passing are hard to calculate right now, but the two senators from both parties have clearly laid the foundation for passage well.  Sadly, there is no companion bill in the US House yet, and getting a sponsor in another body can bring complications.

Right now, this is an elegantly simple bill that does indeed level the playing fieldbetween banks of various sizes and takes the taxpayer off the hook.  There is no better way to put an end to both socialized risk and excessive regulation all at once.

Despite the gridlock in the Senate, the Brown-Vitter TBTF Act has a good chance to pass.  It’s worth keeping the pressure on all of Congress, especially the House, to make this happen.

This post was written by Erik Hare and originally published on Barataria. Follow Erik on Twitter: @wabbitoid.

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