Over the past three decades, the U.S. financial system has suffered a nasty financial shock every half dozen years or so, on average. And each incarnation has been different — from the 1987 stock-market crash to the savings-and-loan crisis to the demise of Long-Term Capital Management to the Great Global Financial Crisis, which arguably began six years ago this summer with the collapse of two Bear Stearns hedge funds.
If life were like the movies, it would be time for some world-weary-but-knowing character to drop the now-hackneyed line, “There’s a storm coming.” And whatever form that storm might take, would Wall Street be ready to weather it? Or more important for Main Street, would the U.S. economy be able to withstand another financial blowup without resorting to yet another taxpayer bailout?
What silly questions. The Obama administration has already checked off the “Strengthen Financial System/End ‘Too Big (and Interconnected) to Fail’” box on its policy agenda with the 2010 passage of the Dodd-Frank financial-reform law.
Except almost nobody actually believes Too Big to Fail has ended. Certainly not megabank regulator Ben Bernanke. As the Federal Reserve chairman told a Senate panel earlier this year: “We need to stop Too Big to Fail. As somebody who has spent a lot of late nights trying to deal with these problems and the crisis, I would very much like to have the confidence that we could close down a large institution without causing damage to the rest of the economy.”
And at least publicly, Bernanke is taking a wait-and-see approach to Dodd-Frank, as regulators continue to write rules fleshing out the legislation. His patience, however, may not be rewarded. A key part of Dodd-Frank is the provision that the biggest banks provide “living wills” that would instruct regulators how to safely wind them down should they become insolvent. Technocrats to the rescue.
But the Federal Deposit Insurance Corporation official responsible for dealing with megabank bankruptcy tells Bloomberg Businessweek that none of the biggest banks have yet been able to devise credible plans. And it’s an “open question” whether the wind-down process is viable. That’s a big problem. If it’s an open question whether the living wills will work, then it’s an open question whether Dodd-Frank has solved the major problem it was created to address.
So are we back to the pre-crisis status quo, then? If only. The nation’s five biggest banks (JPMorgan Chase, Bank of America, Citigroup, Wells Fargo, and Goldman Sachs) are now bigger than they were then: Their nearly $9 trillion in assets equals 55 percent of U.S. GDP versus 43 percent five years ago. And those numbers ignore the fair value of their holdings of derivatives. If you take those into account, the FDIC’s Thomas Hoenig explained in congressional testimony last week, JPMorgan alone has nearly $4 trillion of assets, equivalent to 25 percent of nominal GDP. And the eight largest U.S. “systemically important financial institutions” have $16 trillion in assets, including derivatives, which is the equivalent of 100 percent of GDP.
But downsizing and restructuring America’s Too Big to Fail, Too Complex to Manage financial system isn’t just about preventing crises and bailouts. The “financialization” of the U.S. economy may be bad for growth generally. A 2012 Bank for International Settlements study found that a “fast-growing financial sector is detrimental to aggregate productivity growth” for rich economies. A 2008 study by Roosevelt University economist Ozgur Orhangazi found that increased financial investment can “crowd out” investment in the “real” economy. And a 2010 analysis by former UK financial regulator Adair Turner was unable to find any “clear evidence that the growth in the scale and complexity of the financial system in the rich developed world over the last 20 to 30 years has driven increased growth or stability.”
Washington might want to nudge true financial reform to the top of its to-do list. And the sooner, the better. Otherwise, America better get ready to take shelter again.
— James Pethokoukis, a columnist, blogs for the American Enterprise Institute.