The Banks Are Too Powerful To Fail

Roddy Boyd, whose latest book is Fatal Risk: A Cautionary Tale of AIG's Corporate Suicide, earned my respect immediately in a recent interview with the Daily Ticker's Dan Gross and Aaron Task. Asked about the still enormous risks in the financial system, Boyd said—

... the fundamental issues are A — leverage in our banking system; and B — what I call the Glass Steagall problem, which is we don't have it anymore. [everybody laughs]

Commerical banks are now investment banks, and also hedge funds. And investment banks are fine things, hedge funds are fine things, and so are commercial banks, but having them all under one roof, with direct access to the Fed funding mechanism, I'm worried and I think this [another meltdown] is going to happen again.

I don't write much about Wall Street anymore, preferring to focus on how badly things are going on Main Street. But as Aaron Task points out, if you listen to President Obama or other propagandists, the Dodd-Frank financial "reform" bill solved the problem of having banks that are too big to fail. Now there is a "resolution authority" which could be used to unwind the operations of a big bank that has blown up. But that authority is a ruse, as Richmond Federal Reserve President Jeffrey Lacker pointed out the other day.

ROANOKE, Virginia (Reuters) - Large financial firms should be allowed to fail or they will continue to take excess risks that lead to crises, Richmond Federal Reserve President Jeffrey Lacker said on Thursday.

Lacker said a very proactive response to the financial crisis, while stabilizing the situation in the short-term, has simply expanded the government's implicit safety net to nearly two-thirds of the financial system.

That raises the chances that such companies will continue to have unfair advantages and not adequately prepare for possible losses on their investments because they expect the government to step in when troubles arise.

Having an implicit guarantee from the government is referred to as Moral Hazard. Lacker continues.

"It is not clear that recent reforms have succeeded at closing the gap or limiting the safety net," Lacker [left] told students at an event sponsored by Ferrum College.

Fed Chairman Ben Bernanke and other top regulators have argued that the Dodd-Frank financial reform law have largely solved the problem of banks that are considered too big to fail by giving the authorities the ability to wind down those firms.

A council of regulators that includes the Fed, the Securities and Exchange Commission and others is soon expected to designate a number of firms as explicitly too large to be allowed to go fail -- and impose tougher regulatory requirements on them.

But Lacker, along with regional Fed presidents Thomas Hoenig of Kansas and Richard Fisher of Dallas, did not suggest the financial regulation overhaul had done the trick.

Instead, it actually may have reinforced the impression in the markets that certain Wall Street firms will always get special treatment.

"The precedents set by intervention during this most recent crisis led to a significant increase in the scope of the safety net," Lacker said.

And at this point in his argument, Lacker makes a novel suggestion—

He said that to reestablish a credible threat of failure for megabanks and other large financial firms would require actually allowing one to go down, even when investors expect it to be bailed out.

You will recall that a too-big-to-fail bank, namely Lehman Brothers, was allowed to fail in October, 2008. However, it was not allowed to fail in an orderly way, and all hell broke loose. One day it was there, and the next day it was gone. But that was then, and this is now. Lacker is talking about letting Citigroup or Bank of America or—God Forbid—Goldman Sachs fail. As the Daily Ticker reminds us, the too-big-to-fail banks are now way too-big-to-fail.

In addition to expanding the safety net and reinforcing the notion of "too big to fail", the 2008 bailouts resulted in an even greater concentration of risk in the financial system as, most notably, JP Morgan absorbed Bear Stearns and Washington Mutual; Bank of America took over Countrywide and Merrill Lynch; and Wells Fargo took over Wachovia...

Rather than raise capital requirements — which JP Morgan Chairman and CEO Jamie Dimon says would be a "nail in the coffin" for America's big banks — or other regulatory handcuffs, Boyd says the government should "lovingly apply a scalpel" to the biggest banks; in other words, "break 'em up."

Because of the continued use of leverage and interconnectedness of financial firms, more bailouts are likely if and when another crisis hits the system, whether it's triggered by U.S. real estate, Europe's debt crisis, currency markets or upheaval in China...

Now, seriously: is there anyone in the United States who actually believes any of the big banks would be allowed to fail? Boyd says we should "break them up" and we should. Shoulda, woulda, coulda. He points out that America did many great things after Glass-Steagall was passed in 1934. Thus there is no reason for us to carry these enormous risks in the banking system. But again, that was then and this is now. The Empire has been declining for decades. The political power of the banking system is part & parcel of that decline.

Although it did not seem that way during the Great Depression, America's best days were ahead of it in 1934. Now those days are long behind us. Nobody is talking about reviving Glass-Steagall, a wise law which kept us safe for 65 years until it was repealed in 1999. In 2011 you will hear many self-serving excuses about why such a law would overly constrain the banks, why it would make them less competitive. It is as if the natural order of things is for all commercial banks to be investment banks and hedge funds too.

That's why I don't write about the banking system anymore. The game is rigged, the fix is in—see CNN Money's Delaying debit card fee cap gains momentum. The big banks are too politically powerful to fail.

Here's the video.