Too Big to Fail is Being Fixed

Isn’t everyone excited?

April 16, 2009

By Paul Davis, American Banker

“Too big to fail” is destined for a fix as policymakers look for ways to prevent financial services companies from becoming excessively large or complex.

The options for reining in scale remain varied yet vague, ranging from straight asset caps to systems that could require more capital or bigger fees as banks expand.

Those who back restricting growth point to Citigroup as a textbook example of a complex and sprawling banking company that became too big to manage. In January the $2.02 trillion-asset company split into two units: one that includes core businesses and another with about $850 billion of assets that Citi plans to sell or wind down.

Kevin Jacques, the chairman of finance at Baldwin-Wallace College in Berea, Ohio, is among those who expect a regulatory crackdown on the big banks.

“The megabanks tend to keep their [capital] ratios relatively close to the regulatory minimums,” said Jacques, who spent a decade with the Office of the Comptroller of the Currency before a stint as a Treasury economist. “Another possibility is that we will see enhanced additional supervision and oversight of activities.”

Christopher Whalen, the managing director at Institutional Risk Analytics, noted that federal law already bars a bank, once it controls 10% of the nation’s deposits, from growing by acquisition. He is advocating a similar cap on a bank’s liabilities. In doing so, regulators would also put restrictions on a company’s short- and long-term borrowing and indirectly force it to rethink the asset side of the balance sheet.

“If you know you can only grow your business to x-size, you would make different choices, particularly on acquisitions,” Whalen said. “If you are determined to be a systemic risk, you will be penalized. It will become clear to management that there is a penalty for size and a progression toward smaller, more efficient institutions that are more manageable.”

Regulators may encourage other companies to mimic Citi by identifying and selling untraditional business lines.

Karen Shaw Petrou, the managing director of Federal Financial Analytics, said that would not only shrink the “too big to fail” companies, but it would also spread risk among a larger group of participants.

"I think there will be a rationalization, she said. “I think we will see a model where the institutions redefine their core competencies.”

Many observers view setting ceilings on balance sheets as heresy.

Andrew Senchak, vice chairman and co-head of corporate finance at Keefe, Bruyette & Woods, said even determining what businesses pose systemic risk would be difficult. “It is a very complicated process. What is systemic risk? Perhaps it would prove much more productive if they simply identify the activities and regulate them properly.”

Others said balance-sheet caps of any kind could inhibit lending and discourage the big banks from taking on added functions that keep the industry and the entire financial system afloat.

“In my opinion this would be regulation at its most stupid,” said Gary Townsend, the president and chief executive of Hill-Townsend Capital. “The regulators spent the last 20 years trying to put together a framework based on risk-based capital. This is still the best approach, when combined with competent regulation.”

Peter Schild, a former head of internal audit at Wachovia, said there are also concerns that caps could force more activities off banks’ balance sheets. “The notion of paring back either side of the balance sheet would raise a ruckus,” he said.

Terry Maltese, the president of Sandler O’Neill Asset Management, noted that it was the industry’s biggest players, such as JPMorgan Chase and Wells Fargo, that were able to help the government by buying Washington Mutual, Bear Stearns and Wachovia.

“Imagine what would have happened during this cycle if we had size limits,” Maltese said. “Some of the biggest banks ? would have been unable to grow further” and would have been unable to assist in the cleanup. “So an asset cap really isn’t practical.”

Others cite Bank of America’s purchase of the New York investment bank Merrill Lynch as an example of a strong bank weakening itself ? at least in the short term ? by swallowing up a beleaguered target, placing both itself and regulators in a tenuous position.

Gwenn Bezard, a research director at the Boston consulting firm Aite Group, said any effort to rein in the biggest banks must weigh the ramifications. “It would have proven counterproductive in this crisis,” Bezard said. “There are always concerns that regulators’ reactions to today’s problems could actually nurture tomorrow’s dilemmas.”[/quote]

Did it make anyone else think of Atlas Shrugged?

This would be a mess. No way do the feds have the capacity to do this effectively or efficiently.

They will make rules. Banks will find loopholes. They will make more rules.

The problem is two fold. First, when they propose regulation they are severly clouding market signals. Placing artificial barriers or rewards only encourages economic activity that, more than likely, would not have been as as attractive in a free market.

They will, in effect, shift economic resourses in directions they deem acceptable. Every part of the economy is organic and must react to market signals. When these signals are distorted or conterfitted we lose an incredible amount of efficiency.

Secondly. This type of control will most certainly be for sale. Regulation wil be manipulated to favor political allies just like is always is. At least until they hand it over to unelected bureaucrats, which is another quite serious issue.