The Senate gets into the swing of bankwhacking

Some months ago, as health care reform languished and the Senate ground nearly to a halt, one read frequent laments that the moment for sweeping financial reform was being wasted -- that by the time the Senate got around to full consideration, memories would have faded, rage against the banks cooled, and lobbyists' hooks sunk ever deeper. 

Reasonable worries, perhaps. But those who despaired of strong reform did not reckon on HCR passage changing the dynamic in Congress; or on the pressure that would be generated by bringing the bill to the floor just as election season heated up; or on the fresh spur to rage afforded by an SEC suit (and criminal investigation) against the nation's most lucrative financial institution.

Just nine days ago, Jonathan Chait was marvelling at the strength of the Dodd ill as it came to the floor. Now, the WSJ reports, a tide of amendments is bidding to restrict financial institutions' activity far more radically:

Sens. Ted Kaufman (D., Del.) and Sherrod Brown (D., Ohio) plan an amendment that would prohibit any bank from ever holding more than 10% of the country's deposits and put strict caps on the debt banks issue.

Sens. Maria Cantwell (D., Wash.) and John McCain (R., Ariz.) have worked on an amendment that would force commercial banks to separate from investment banks—revisiting the Glass-Steagall Act of the 1930s.

Sens. Jeff Merkley (D., Ore.) and Carl Levin (D., Mich.) plan a provision to forbid banks with federally insured deposits from certain trading activities.

Mitch McConnell, bank-shrinker?

Ezra Klein has beat me to it again.  Today Mitch McConnell came out against Dodd's bank reform bill,  claiming that by setting up and funding a resolution authority that enables regulators to liquidate the largest financial institutions in an orderly fashion if they become insolvent, it is enabling and in fact guaranteeing future "bailouts." "“This bill not only allows for taxpayer-funded bailouts of Wall Street banks;  it institutionalizes them,” McConnell pronounced.

Klein points out that McDonnell is equating a liquidation that wipes out shareholders and management with a bailout -- and further notes that McDonnell is following to the letter a political strategy laid out by GOP pollster Frank Luntz in February: to equate any Democratic bank reform bill with the hated bailouts of 2008-09.

Cynical indeed. As Klein suggests, if you don't want to give regulators resolution authority over banks currently considered too big too fail, it would seem you would have to be in favor of not allowing banks to grow, or stay, too big to fail.   I would add that the only intellectually consistent, if insane, alternative to  breaking up, shrinking, or reining in today's behemoths or making provisions for their orderly liquidation is to take the position taken by many of the most ignorant and extremist Republicans in fall 2008: let 'em all fail and let the chips fall where they may. Pull down the whole temple of global finance around our ears.

But McConnell is not that crazy. He acknowledged last October that TARP “succeeded in stabilizing the banking system.” It seems fair to assume that he believes that the Federal government can't simply step back and let too-big-to-fail banks enter bankruptcy. That brings us back to Klein's question:  what steps would McConnell favor to make the behemoths smaller, or otherwise enable them to fail without systemic risk?

A tailor's yard for cutting megabanks to size

Ever wonder how a regulatory regime with a mandate to break up banks that are "too big to fail" would operate?  Every article I recall reading on the subject treats the question structurally -- that is, by addressing what activities a single financial entity should not be allowed to engage in simultaneously. For example, Paul Volcker recently recommended forbidding deposit-taking banks from engaging in proprietary trading. John Gapper has proposed.separating the functions of retail banks, investment banks and asset managers.

But leaving aside function-based restrictions, how would a regulator determine how big is too big -- literally, from the standpoint of creating systemic risk?  Peter Boone and Simon Johnson, posting on The Baseline Scenario, provide a legislative update, an analogy, a guideline, and a recommendation:

The Kanjorski amendment recognizes that the systemic and societal danger posed by banks can be hard to recognize, and it proposes a number of potential objective criteria that could be used by the Financial Services Oversight Council (to be created by legislation in progress) to determine when banks need to be broken up, including the “scope, scale, exposure, leverage, interconnectedness of financial activities, as well as size of the financial company.”

The Kanjorski amendment does not impose a hard size cap on banks, but lawmakers in the House are discussing amendments that would do so.

There is, of course, a strong precedent for capping the size of an individual bank: The United States already has a long-standing rule that no bank can have more than 10 percent of total national retail deposits.