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Undernews is the online report of the Progressive Review, edited by Sam Smith, who covered Washington during all or part of ten of America's presidencies and who has edited alternative journals since 1964. The Review, which has been on the web since 1995, is now published from Freeport, Maine. We get over 5 million article visits a year. See for full contents of our site

March 2, 2010


PETER BOONE, SIMON JOHNSON, NEW REPUBLIC - As a result of the crisis and various government rescue efforts, the largest six banks in our economy now have total assets in excess of 63 percent of GDP . . . This is a significant increase from even 2006, when the same banks' assets were around 55 percent of GDP, and a complete transformation compared with the situation in the United States just 15 years ago, when the six largest banks had combined assets of only around 17 percent of GDP. If the status quo persists, we are set up for another round of the boom-bailout-bust cycle that the head of financial stability at the Bank of England now terms a "doom loop.". . .

Proprietary trading is but a small part of what these banks do. For most of the major banks, such activity accounts for less than 5 percent of total revenue--even at Goldman Sachs, which is, in some senses, the largest hedge fund in the world (backed by the U.S. government through its access to the Fed's discount window), proprietary trading accounts for only around 10 percent of total revenue on average. Even if we could strip this activity from the banks, it would reduce their size only slightly--and the too-big-to-fail banks would find ways to take similar-sized risks because their upside during a boom would still be big, and their downside in a bust would dramatically damage the economy, thereby forcing the government into some sort of rescue.

Implementing the proposed nominal size cap would not make any difference either. The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 specified a size cap for banks: No single bank may hold more than 10 percent of total retail deposits. This cap was not related to antitrust concerns, as 10 percent of a national market is too low to imply pricing power. Rather, this was a sensible macro-prudential preventive measure--don't put all of your eggs in one basket. Unfortunately, since 1994, two limitations of Riegle-Neal have become clear: (1) The growth of big banks was not fueled by retail deposits, but rather by various forms of "wholesale" financing (in which financial institutions lend to other financial institutions); (2) The cap was not enforced by lax regulators, so Bank of America, JP Morgan Chase, and Wells Fargo all received waivers in recent years.

Even in the most generous interpretation, the administration is proposing only to freeze the size of our largest banks, not to reduce their scale. . . A senior administration official explained, "The liability cap will be structured in such a way that it constrains future growth that leads to excessive concentration in our financial system. It's not designed to reduce the share of any existing firm."

Why would anyone regard 20 years of reckless expansion, a massive global crisis, and the most generous bailout in recorded history as the recipe for creating "right-sized" banks? There is absolutely no evidence, for example, that the increase in bank scale since the mid-'90s has brought social benefits. . . . By contrast, the huge social costs are readily apparent--in terms of direct financial rescues, the fiscal stimulus needed to prevent another Great Depression, and the appalling number of lost jobs (eight million gone since December 2007, and still counting). Volcker Rules or no, the president apparently still doesn't get this.

Unfortunately, even if he did, it might not make much difference. The banks understand that if they are large enough and all get into trouble in a roughly similar manner at about the same time, there will be incredibly generous bailouts. When forced to choose between global economic collapse and expensive financial system rescue, they reckon that no government will really let them fail. And they have every basis for this belief--the people who run our mega-banks have, with very few exceptions, kept their jobs, their bonuses, their pensions, and most of their social prestige. . .

Unfortunately, solutions that depend on smarter, better regulatory supervision and corrective action ignore the political constraints on regulation and the political power of today's large banks. The idea that we can simply regulate huge banks more effectively assumes that regulators will have the incentive to do so, despite everything we know about regulatory capture and political constraints on regulation. . .

Here lies the crux of the problem: The Obama administration lacks an inner core of smart, well-informed advisers who are deeply skeptical of big banks and eager to do whatever it takes to break a cycle that points to financial and fiscal doom. While Paul Volcker's belated ascension from the basement is an encouraging sign, he remains a lone voice in an otherwise inertial regime.


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