Despite how you measure them, the four largest United States banks — JPMorgan Chase, Bank of America, Wells Fargo and Citigroup — are mammoths.
With a greater market share than ever, their combined assets are $7.8 trillion, which is nearly half the size of the entire U.S. economy.
Indeed, these financial institutions are so large and interconnected that they have been deemed “too big to fail.”
As a result, market participants believe the U.S. government will always be there to bail them out in a pinch, as their failure would be disastrous to the overall economy.
Certainly, if you are of the belief that actions speak louder than words, Washington has done literally everything in its power to reinforce the notion that they would lend extraordinary help to enable TBTF banks to survive.
In 2008, at the peak of the financial crisis, the government stepped in and decided which Wall Street megabanks would receive a taxpayer-funded bailout, because they were considered too economically vital to fail.
Put simply, the U.S. government did what any economics textbook will tell you not to do: hand-select economic winners and losers.
More importantly, however, the U.S. government created a terrible precedent. By refusing to allow these financial institutions to fail, banks essentially received an unspoken guarantee that the government would always be there in a time of need.
It’s the perfect insurance policy — and the large banks are taking full advantage.
Right now, the biggest U.S. banks enjoy a massive competitive advantage in that they’re able to borrow and lend money far more cheaply than other, smaller banks, because everyone on Earth knows their debt is pretty much government-guaranteed.
Additionally, megabanks are incentivized to engage in excessively risky practices that have a high potential for reward, but carry with it an even higher potential for failure.
Case in point: In April of last year, Bruno Iksil, a trader nicknamed the London Whale and Voldemort, was solely responsible for $6.2 billion in trading loses for JPMorgan Chase’s investment offices.
In essence, what we have is a financial system that rewards banks for their size, rather than quality of operations.
Fortunately, on April 24th, Senators David Vitter, a Republican from Louisiana, and Sherrod Brown, a Democrat from Ohio, spearheaded their campaign to end the era of “too big to fail” banks, by introducing a bill that calls for two things.
First, the bill would make the giant banks much safer.
Indeed, its core provision requires that any bank with more than $500 billion in assets hold a safety cushion of at least 15 percent in capital reserves, which is more than twice the current amount. This provides a buffer for potential loses.
For example, take a hypothetical bank that holds $400 billion of mortgages and $400 billion in bonds. Under the Brown-Vitter bill, it would have to set aside 15 percent of $800 billion, or $120 billion, in capital.
The second important feature of the Vitter-Brown bill is that such a high standard for capital requirements will likely force big banks to spin of much of their business, which would eliminate the systemic “too big to fail” risk they currently impose.
It’s a simple two birds, one stone kind of fix. And our banking system — and the global economy — will benefit substantially from it.
