In Primaries, Too-Big-To-Fail Debate Has Become Too Political To Understand

In Primaries, Too-Big-To-Fail Debate Has Become Too Political To Understand

Recently, the debate on breaking up the banks has moved away from whether they are “too-big-to-fail” to whether they are simply “too big.” Senator Bernie Sanders, MSNBC’s Joe Scarborough and others have argued that since large banks are bigger than they were since the crisis, we must break them up.

Separately, while not advocating break ups, Senator Marco Rubio repeated his talking point that, “The big banks are bigger than they’ve ever been,” and added regional and community banks are being “wiped out.”

The notion that we should break up large banks due to their size is wrong on three fronts.

First, size does not equal risk. The Great Depression and the S&L crisis show that a country full of small banks can still have banking crises. As Fed Vice Chair Stanley Fischer recently put it, “Actively breaking up the largest banks would be a very complex task, with uncertain payoff.”
Second, ending “too-big-to-fail” doesn’t require ending “too big,” but, rather, ensuring large banks can fail without harming the broader economy. To that end, the largest banks have agreed to a 48-hour stay on derivatives contracts, reduced legal entities by one-fifth, and are ahead of pace to meet total loss absorbency requirements to ensure they can execute a single-point-of-entry resolution. The result is that academic research, bond market data, and credit ratings all show markets don’t believe large banks will be bailed out in the event of a crisis.
Third, while the premise of their argument is wrong, critics’ story that large banks keep getting bigger is also far more messy than they portray. In fact, three of the largest banks are smaller since the crisis. Four of the largest banks are smaller since Dodd-Frank. And the largest banks have a smaller footprint in both financial markets and the U.S. economy than before.

Highlighted below are the facts on bank size since the crisis and Dodd-Frank.

1. The big banks do not just keep on getting bigger.

Three of the six largest banks are smaller than 2008. Four of the six largest are smaller since Dodd-Frank and JP Morgan shrunk 6% last year due regulation.

2. Since Dodd-Frank, the largest banks have lost market share.

The median asset growth of bank holding companies with more than $500B in assets is negative, while regional, midsize, and community banks have all seen double digit growth. The fact that large banks are losing market share is confirmed by the Boston Fed, which found that U.S. G-SIBS have lost market share since Dodd-Frank, the IMF which found that the top three banks have lost market share in the United States, and the Bipartisan Policy Center, which found the top five bank holding companies have lost market share since Dodd-Frank. Anyway you measure it, the largest banks are pulling back while other asset classes pull ahead.

3. Since Dodd-Frank, the largest banks are a smaller part of our economy.

Overall, the largest banks have grown at a CAGR of 0.8% since Dodd-Frank, which is four times slower than commercial banks and the economy, and over ten times slower than the S&P. While individually large banks have both grown and shrunk, overall as a group, the largest banks have grown slowly such that they represent a much smaller portion of the U.S. economy and banking sector.

4. The U.S. banking sector is highly competitive relative to other sectors and other advanced economies.

America is home to more than 7,000 banks and 6,000 credit unions, which provide Americans with ample choices in competitive markets across the country.

5. Credit ratings, academics, and bond markets all find evidence that markets believe too big to fail is over.

Banks and regulators have made significant progress to ensure that in the event of a failure, a large bank can be wound down without harming the economy or requiring a bailout. Ending too big to fail does not require ending ‘too big,’ but enabling them ‘to fail.’ Banks have made a number of reforms, while regulators have pioneered a single point of entry strategy to facilitate a large bank wind down.

Reforms

Fed Chair Janet Yellen Pointed Out That Large Banks Have Reduced Legal Entities By One-Fifth. “I would simply say that the regulatory reports that we receive indicate that these firms since 2009 have reduced the number of legal entities in their structures by approximately one-fifth.” (Janet Yellen, Comments To House Financial Services Committee, 7/16/15)
2015 Expansion Of ISDA Agreement To Cover More Transactions “Closes Off Much Of The Cross-Border Close-Out Risk.” “The Protocol closes off much of the cross-border close-out risk that statutory stays have not been able to eliminate because their reach is limited to national borders. I am particularly pleased to see that all sectors of the industry are working together to find a solution to this issue.” (Mark Carney, “FSB Welcomes Extension Of Industry Initiative To Promote Orderly Cross-Border Resolution Of G-SIBs,” Financial Stability Board, 11/12/15)
Chair of FSB Mark Carney Calls TLAC Essential Element To Ending TBTF. “’This new standard, which will be implemented in all FSB jurisdictions, is an essential element for ending too-big-to-fail for banks,’ he [Carney] said in a press release Monday…The FSB said Monday that they would have to hold a minimum of at least 16 percent of its own risk-weighted assets for future crises as from 1 January 2019. It will need at least 18 percent as from 1 January 2022, it added.” (Matt Clinch, “Global Banks Receive ‘Too-Big-To-Fail’ Rules,” CNBC, 11/9/15)

Results:

— Russ Grote, Managing Director, HPS