That’s what we keep hearing from
Washington. Politicians who wrote the Dodd-Frank law insist
that it eliminates the dangers posed by large, politically
connected financial institutions. At a news conference last
week, Ben S. Bernanke, the chairman of the Federal
Reserve, said that higher capital and greater
liquidity requirements for big banks, combined with more
watchful regulators, were making our financial giants
stronger and less likely to require taxpayer backstops.
Outside the Beltway, however, it is
hardly clear that we’ve resolved this signal threat. Big
banks are bigger than ever, and they exert enormous power
over regulators and lawmakers. Increasingly, smaller
institutions can’t compete.
So it was refreshing last week to
hear Kevin M. Warsh,
a former Fed governor, speak candidly and critically about
the government backing that continues to support our largest
banks. Equally refreshing were his prescriptions for
eliminating the too-big-to-fail problem.
“We cannot have a durable,
competitive, dynamic banking system that facilitates
economic growth if policy protects the franchises of
oligopolies atop the financial sector,” Mr. Warsh told
an audience at the Stanford Law School on Wednesday
night. “Those ‘interconnected’ firms that find themselves
dependent on implicit government support do not serve our
economy’s interest.”
Mr. Warsh, who is a distinguished
visiting fellow at the Hoover Institution at Stanford and a
lecturer at Stanford’s Graduate School of Business, left
government in 2011. His last position was at the Fed, where
he was a governor for five years. Given his front-row Fed
seat during the financial crisis, his views on preventing a
repeat of it carry some weight.
Put simply, Mr. Warsh does not
believe that higher capital standards for banks and greater
regulatory scrutiny will be enough to prevent future
taxpayer-financed bailouts. “At core, I’m worried that the
Dodd-Frank Act doubles down on regulators, gives up on
markets and outsources capital requirements to an
international standards group in Basel, Switzerland,” he
said in an interview last week.
Importantly, none of these responses
have moved us closer to “ridding the United States financial
system of large, quasi-public utilities atop the sector,” he
said.
Mr. Warsh does not prescribe
breaking up giant institutions. Rather, he says their
disclosures must be subject to new and ramped-up
transparency requirements so investors can differentiate
strength from weakness.
“The Federal Reserve’s most recent
stress tests — particularly the enhanced disclosure — are a
step in the right direction,” he told his Stanford audience.
“Still, disclosure practices by the largest financial firms
remain lacking, and the periodic reporting overseen by the
Securities and Exchange Commission tends to obfuscate as
much as inform.”
Regulators must require clearer and
more expansive disclosures so that the financial statements
and associated risks of large and complex companies can be
assessed, Mr. Warsh said. If investors had more detailed
information from these institutions, they would very likely
sell their shares and debt if they took too many risks. This
would hold the managers of these institutions accountable
for reckless behavior by making them pay more to fund their
businesses.
But this powerful market force is
ineffectual in a world where investors believe that the
government will save faltering institutions. “Unfortunately,
the Dodd-Frank Act has only reinforced the view that big and
troubled banks will receive special government assistance,”
Mr. Warsh said in his speech. “By sanctioning some list of
too-big-to-fail firms — and treating them different than the
rest — policy makers are signaling to markets that the
government is vested in their survival.”
Mr. Warsh also questions our
nation’s participation in the Basel negotiations regarding
bank capital requirements. He pointed out that many of the
countries working alongside the United States on these rules
back their banks more explicitly than we do. Therefore,
their approach to capital standards is bound to vary greatly
from ours.
“My concern is that the negotiation,
while well intended, is between banking systems that at
their core are fundamentally different and aspire to
fundamentally different things,” he said. “The largest banks
in Japan, Germany, for example, have long been akin to
national champions. Perhaps they reason that their banks
need less capital than ours because their sovereigns more
assuredly stand behind them.”
Our financial regulators, Mr. Warsh
suggested, should work with countries that don’t explicitly
back their largest institutions. “We should work with them
to instill real market discipline and real capital levels
and do a more rigorous job on regulation,” he said. Britain
and Switzerland are two possible candidates for this joint
effort, in large part because their banks are too big to be
bailed out by their governments.
CIRCLING back to the pernicious
effects of large and politically interconnected banks, Mr.
Warsh makes a direct link between the favors handed to these
institutions and our disturbingly high unemployment rate.
Small and medium-size banks, after all, are at a competitive
disadvantage to the big guys, so they are less able to lend
to companies of modest size, which do so much of the hiring
in this country.
“The policy has favored large global
banks and disfavored small and medium-sized banks,” he said.
“So I’m not surprised that real economic and job growth that
should come from these enterprises is still lacking. Our
failure to have a dynamic competitive banking system is a
partial explanation for the weakness we are seeing.”
Granted, Mr. Warsh is far
outnumbered by those arguing for the status quo and the
continued hegemony of big banks. Many of those people, not
surprisingly, work in Washington. But their refusal to
concede that taxpayers remain imperiled by banks too big to
succeed only ensures that we will face another financial
crisis. And that it will come sooner, not later.
