‘Too Big to Fail’ Banks Need Tough Regulation

by James Parks, Sep 9, 2009

While the rescue of the nation’s top financial institutions was necessary, the rescue must be accompanied by strong action now to rein in the same institutions that caused the global financial crisis in the first place, several experts said today.

During a forum sponsored by the Economic Policy Institute (EPI), panelists pointed out that the nation’s four largest bank holding companies control nearly half of the bank assets in the country—almost double the amount they controlled in 2002—not a good situation for our economy.

The biggest threat: All these banks are carrying billions of dollars in bad debts. Their weak balance sheets make them hesitant to lend—the so-called zombie bank phenomenon. But their financial weakness is paired with political power, power that may not be consistent with our democratic principles, says Damon Silvers, deputy chair of the Congressional Oversight Panel (COP). 

Silvers, who is associate general counsel for the AFL-CIO, says the banks dubbed “too big to fail”—Bank of America, JP Morgan Chase, Citigroup and Wells Fargo—are not playing their role of financing the real economy—lending to businesses that create jobs.

Instead they are doing high interest, high fee credit card lending and high risk exotic financial products, relying on the government to bail them out if they fail. That doesn’t help homeowners facing foreclosure or small businesses that need capital to grow or the unemployed workers who could get jobs if business expanded, Silvers said.

He said the $10 trillion these four banks control would make a much bigger dent in the recession than the $800 billion in deferral economic recovery funds. Silvers said the executive compensation system needs to be reviewed to force executives to look at long-term goals rather than the short-term. The current system rewards executives for short-term profits. Even if a company fails, the executives don’t suffer because of the way the pay packages are written. 

AFL-CIO Secretary-Treasurer Richard Trumka discussed the need for long-term investment today as well, joining with Warren Buffett and other business, government and academic leaders and the Aspen Institute in a bold call to overcome short-term focus in financial markets.

Their joint statement, “Overcoming Short-Termism: A Call for a More Responsible Approach to Investment and Business Management,” calls for ending the focus on value—destroying short-termism in our financial markets and creating public policies that reward long-term value creation for investors and the public good. The statement also calls for consideration of a financial services transaction tax.

Other speakers at the EPI forum also stressed how the banking system needs to be overhauled and regulated closely. John Boyd, a professor at the University of Minnesota, proposed a straight-forward approach of limiting the size of the banks and significantly increasing regulation.

MIT professor Simon Johnson pointed out that de-regulation of financial services created this economic mess. Unfettered, the financial industry created more and more innovative products that were based on nothing tangible, he said.

Johnson also warned against the revolving door between the banks and the government, saying there should be a five-year ban on employees moving from the Treasury Department to financial institutions and vice versa.

Silvers recommended several key financial reforms:

• An entity other than the Federal Reserve must regulate the banking system. Entrusting the Fed, which at the regional level is controlled by bankers, with regulating the system, is like having the “fox in the henhouse,” he said.
• Global financial regulations must be established.
• Congress should approve the Obama administration’s proposal to create a Consumer Financial Protection Agency. If in the past few years an entity had existed to look out for the financial consumers, the financial suffering would not have been so severe, Silvers said. 

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