Too Big to Fail Banks: Back On Congress's Radar

The U.S. Senate unanimously voted to end the reign of the too-big-to-fail banks last week … well, they voted to condemn the reign of too-big-to-fail banks. Actually, to be perfectly honest, they voted to pass a non-binding amendment flirting with the idea of possibly ending one part of the advantage enjoyed by too-big-to-fail banks: implicit subsidies given by the credit market due to the perception that the banks will be bailed out if they fail.

Progress!

Despite the underwhelming nature of the "Brown-Vitter Amendment" — named after Louisiana Republican Senator David Vitter and Ohio Democratic Senator Sherrod Brown, the amendment's sponsors — it is an important symbolic step that will lead to further progress. It indicates that not only is the perception that banks will continue to be bailed out coming under fire, but that the entire Senate is united in that attack. In a Congress ruled by partisanship and the filibuster, that's an important point.

Even more critically, this amendment is a barometer for a bill that will be introduced next month by the same pair. The upcoming bill will target six U.S. banks, forcing them to play more conservatively on the market through additional capital requirements.

The targeted banks — those possessing over $500 billion in assets — are: JPMorgan Chase & Co., Bank of America Corp., Citigroup Inc., Wells Fargo & Co., Goldman Sachs Group Inc., and Morgan Stanley.

The goal of the upcoming bill is to incentivize the country's largest banks to break up, similarly to how U.S. oil and phone companies have been broken up in the past. Congressman Brown argues that the banks have exceeded the size necessary for maximum economies of scale, and could thus enjoy even more returns if broken up, making the economy less dependent on these few powerful players in the process.

Needless to say, the financial industry is less than enthusiastic about this potential new regulation. Tim Pawlenty, former Minnesota governor, Republican presidential contender, and current CEO of the Financial Services Roundtable, said in a recent interview that the 2010 Dodd-Frank Act was sufficient to combat the too-big-to-fail mentality if given time to take full effect. According to him, the problem is not with the banks, but with the bailouts.

"Nobody wants to bail out big financial institutions;" explained Mr. Pawlenty, "the financial institutions would even say that. So we need to have a law that prohibits that, and that's exactly what Dodd-Frank does."

Obviously, given the benefits that the banks have been reaping from investors confident in their unsinkability, not everyone in the market agrees.

And given the fact that these banks accepted the bailouts rather than go bankrupt according to their free-market principles, even the banks don't seem to agree with their own assessment.