Michele Walk, Associate Editor
Ideology: Moderate | Writing From: George Washington University
Last Friday, Vermont independent Senator Bernie Sanders introduced legislation called the “Too Big to Fail, Too Big to Exist Act” that would require the Treasury to break up financial institutions (commercial and investment banks, hedge funds and insurance companies) that are deemed “too big to fail” so that “their failure would no longer cause a catastrophic effect on the United States or global economy without a taxpayer bailout.” In refreshing contrast to the cumbersome nature of most legislation (most notably, Speaker Pelosi’s 2,000 page plus health care bill), the entire Act is only two pages.
The New York Times quoted Mr. Sanders: “We should end the concentration of ownership that has resulted in just four huge financial institutions holding half the mortgages in America, controlling two-thirds of the credit cards and amassing 40 percent of all deposits.” Sanders refers to Citigroup, Bank of America, Wells Fargo and JPMorgan Chase, which the administration has singled out as “Tier 1 Financial Institutions” that it needs to protect; that is, firms that are “too big to fail.”
This obsession with protecting firms that are “too big to fail,” however, will not solve our economic problems. It especially won’t ward off future crises and bailouts. As former IMF chief economist Simon Johnson has argued, guaranteeing these large financial institutions free flows of taxpayer dollars does not help the US economy in the long run. Financial institutions with access to Treasury funds should be required to pay a “substantial long term annual fee to compensate taxpayers for that access.” This free borrowing of money from the government – something they would never extend to their own customers – gives them a sense of security that they do not deserve, and only encourages large financial institutions to continue the high-risk practices that contributed to the economic mess we are currently in. Sanders’ legislation would prevent such institutions from getting to the point where they could even consider needing a taxpayer bailout.
The bill, however, will likely face significant opposition in Washington. The irony is that Sanders, a self-identified socialist, is actually acting more in line with fundamental capitalist thought than any of the supposed “pro-business capitalists” on Capitol Hill. Competition between a large number of firms is at the heart of a solid capitalist system, and having a higher number of small financial firms each with marginal market share would help the US economy and consumers. It is one of the basic aspirations of any firm to grow larger and increase their market share to the point where they are the main, if not only, viable business in their sector. As the financial crisis has shown, this is not only a dangerous situation for the firms themselves but for the entire economy.
The term “too big to fail” needs to fail itself. We cannot allow financial institutions to operate as if the government will save them regardless of how risky their behavior is. Not only does this policy bankrupt our nation and further drive up our national debt, it is anti-capitalist: it reduces competition and encourages oligopolistic behavior. Busting up large institutions would not be a new policy, either: Republican Theodore Roosevelt faced a similar situation in the early 20th century, when he became famous for “busting” the Sugar and Oil trusts. Much like Theodore Roosevelt, it is time for the Obama Administration to break up these financial behemoths. Having such large institutions is a liability to our economic well-being that we just can’t afford anymore.
Well we can’t discriminate against institutions that manage to grow and still retain quality standards. I really don’t agree with this legislation, it overlooks the problem of financial institutions receiving special government treatment in the first place. If we had just let them fail in the first place then today we would see smaller institutions competing for customers who base decisions more on safety than windfall profits.
and one more thing, who decides if it is “to big to fail”? I can see this being abused very easily.
Om, the Administration is currently compiling a list of institutions deemed “too big to fail.” I agree that there are complications with this terminology and deciding exactly which institutions are “too big.” However, last fall’s financial crisis and the ensuing drama have made it clear that it is not healthy for the economy to have institutions so large that their collapse would destroy the rest of the industry and the economy. I assume that market share would play into this calculation significantly, and once an institution reaches a certain threshold they would be required to break up.
I disagree that this “overlooks” the problem of financial institutions receiving government funding; in fact, that is the root of this bill. I assume what you’re alluding to is prohibiting government bailouts entirely. I agree that it would have been ideal to let them fail in the first place (I wrote my first article for Politicizer on that topic), but most economists agree today that would have been a very traumatic situation, and while it would have been better for the economy in the long run, the sky was falling at the time. This legislation – or rather, this idea in general, since I do have minor issues with this legislation – would prevent us from getting back into that situation in the first place. Unfortunate as it is, we need the government to break up these giants.
If you have further interest in this topic: a paper written by two prominent bankers is making quite a stir, on the “doom loop” that is the new boom-bust-bailout cycle. Highly informative, and probably one of the most influential papers in economics of the year: http://www.bis.org/review/r091111e.pdf