A principal conservative critique of the Dodd-Frank banking reform act is that it didn’t address the central problem of the 2008 financial crisis, the large banks that are “too big to fail.” As Peter Wallison and Cornelius Hurley put it in Forbes, “The Dodd-Frank Act compounds the [too-big-to-fail] problem by declaring that every banking organization larger than $50 billion is ‘systemically important.’” That, in turn, allows large banks to raise money at lower interest rates than smaller banks, because their implicit federal backing makes them more credit-worthy than the smaller firms.
But do conservatives have a better solution to Dodd-Frank on this point? For the most part, conservative alternatives to Dodd-Frank are not that different: forcing banks to pay into a bailout insurance fund, for example. But what if the insurance fund isn’t big enough to cover all of the failing banks’ liabilities?
Ultimately, we can’t solve the “too big to fail” problem unless we address the core problem: that some banks are too big.
So here’s an un-vetted idea I want to throw out there for financially sophisticated Corner readers and commentators to consider: Would it be feasible to pass a law requiring banks above a certain size—say $100 billion in assets—to exist as private partnerships, instead of publicly traded entities?
This way, banks could continue to be large, if they wanted to be. It’s probable that certain types of banking functions are best managed at banks with substantial scale. But if those large banks were structured as private partnerships, in which the partners were financially liable for failure, those banks would be heavily incentivized to be conservative in the way they managed their books, substantially diminishing the risk that they would need to be bailed out in the future.
Prohibiting banks from being publicly listed on any exchange, domestic or foreign, may be logistically challenging. I would imagine the SEC would need to be involved. But if it could be done, such an approach might allow us to avoid a heavy-handed break-up of the big banks, while giving them a choice: stay big, and own the risks in your portfolios, or go small, if you insist on offloading your risks onto shareholders and creditors.
— Avik Roy is author of The Apothecary, the Forbes blog on health-care and entitlement reform. He is a member of Mitt Romney’s Health Care Policy Advisory Group. You can follow him on Twitter at @aviksaroy.