Megabanks, Hoist with Their Own Petard?

Ezra Klein had a very interesting positive thought in his column from yesterday:

The Capitol today is thick with financial wonks arguing that too-big-to-fail is too-big-to-exist and working to devise the policies that would break the banks into smaller pieces. Some say we need to dismantle the big banks totally. Others suggest levying a hefty tax on assets above a certain threshold so that size is penalized. Still others advocate onerous capital requirements that would make too-big-to-fail banks too cautious to implode. In a future crisis, reformers will have a menu of options to choose from. And, in a development that should worry the financial sector, these ideas have gained traction on the left and the right, among radicals and establishmentarians…

Wall Street has fought viciously against the Dodd-Frank financial reforms. A remarkable, 10,000-word article in this magazine by Haley Sweetland Edwards vividly details the coordinated attack the financial industry has mounted through the rule making process. There’s a real possibility that Wall Street will manage what George W. Bush memorably called a “catastrophic success.” If the financial sector is too effective at evading meaningful reforms, then it’s probably only a matter of time before some too-big-to-fail institution self- detonates, putting the entire economy at risk.

I’ve always thought the case for breaking up the banks was mostly a political one. In reality, no bank is “too small to fail”—a single small failure has historically been enough to start a catastrophic panic. Luckily, we have the FDIC to step in and smoothly take over a failing small bank and no one worries about it.

One could imagine a similar procedure for a really huge bank, where the government would step in and wind things down in an orderly way. But if you read Haley’s piece (and you really should) you’ll see the effect of the banking lobby’s power and money on the regulatory agencies. The bankers have lashed the poor buggers into a defensive crouch, and ground the gears of the rulemaking process nearly to a halt. The regulators—and there are ones that are really trying to do a good job, not just angling for a job on Wall Street—simply do not have the raw muscle to beat back that kind of assault.

Busting up the largest banks definitely won’t end financial sector lobbying. But nearly anything that hurts their power and influence is worth doing, especially if it’s big and obvious. Heaven knows the regulators could use a little bucking up.

Ryan Cooper

Ryan Cooper, a contributing editor of the Washington Monthly, is currently the Washington correspondent for The Week.