The policy prescription: BREAK UP THE TOO BIG TO FAIL BANKS. The too big, too complicated banks must be broken up with strong, new regulatory and antitrust rules in place. No financial institution should be allowed to grow so complicated that they can continue to dominate our politics and and get away with risky and predatory practices. Any bank that's "too big to fail" is too big for a free market to function.


Our policy positions on Too-Big-To-Fail, Breaking up the Banks, Usury, Systemic Risk Regulation, and Financial System Overhaul can be found below.


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Some Solutions for the “Too Big To Fail” Problem

New laws should be put in place that minimize the risk of companies becoming “too big to fail.” No single institution should be such a large part of the market that the effects of its failure threaten the whole banking industry, or the whole country’s economy. Instead, we should encourage a vibrant, diverse, stable banking system, made up of thousands of small and medium-size banks. Strong competition policy and antitrust laws will encourage financial institutions to invest in productive activity, instead of investing in changing the rules of the game or manipulating the market.

There are several reasons we need a stronger, scale-based competition policy for the financial-services industry:

A financial-services industry with a few major players is less stable than a financial-services industry with hundreds of small and medium-size banks.

The largest financial-services companies do not provide better services to consumers than small and medium-size banks.

The largest financial-services companies have not in fact been more “innovative” in a way that serves consumer needs (although they have been more innovative in ways that serve to confuse ratings systems and consumers).

The larger and more complex financial-services companies are highly bureaucratic and inefficient, and the instruments they create are more difficult to understand.

Large financial-services companies have disproportionate power over the political process. Concentrated financial power leads to concentrated political power; if you have a lot of cash, one of the most efficient uses of it to maximize profits is to petition the government to change the rules in your favor. Economies of scale work too well when it comes to influencing government.

Companies often grow too large even for themselves. As lawyers and economists have long understood, corporate managers often seek growth at all costs, even against their companies’ interests, in the pursuit of personal wealth, power, and prestige.

To respond to these serious, systemic risks, we need a fundamentally different set of laws governing financial institutions. The idea of a “systemic risk regulator,” currently popular in Washington, is distracting and potentially dangerous because it does not address the underlying problems. A systemic risk regulator would probably not be sensitive enough to new types of risks. It could suffer from the same complacency and overconfidence in models that helped lead to the economic crisis in the first place. It wouldn’t have the power to reshape a whole industry to make it more stable, and it could fall prey to the same risks as the Fed, such as those from cognitive limitations and ideological capture. Instead of a weatherman giving us warnings, we need new laws that would break up existing financial institutions and set a size limit on how big they can become.

Competition policy could prevent much of the systemic risk that has crippled our economy. By focusing on size and concentration, we might be able to avoid collapse, unplanned nationalization, and bailouts.

Here are some possible ways to get from where we are (an industry with increasing, dangerous concentration), to where we’d like to be, a diverse and stable industry made up of thousands of small and medium sized banks and credit unions.

1) The broadest and more general solution is simply to limit corporate size. Size could be computed in several ways: revenue, profits, various and theoretically elusive conceptions of market share, and even the number of people employed by a company. The advantage of a simple size limit is that it would avoid vesting too much judgmental discretion in governmental agencies that might be subject to political pressure. The main disadvantage is that it is inflexible and can prevent the economic efficiencies that come with size, although we believe traditional economics overplays these efficiencies, and the evidence suggests that medium-sized banks perform better and are less risky. A law like this could be enforced by an expanded antitrust division in the Department of Justice, which already performs all the functions that would be necessary for this new law to work: investigations, review of mergers, and bringing enforcement actions to break large companies apart.

2) Congress could expand and strengthen deposit caps and similar limits. A federal law currently restricts any bank from coming, through mergers, to hold more than 10 percent of the nation’s bank deposits. The 10 percent cap could be changed to 5 percent. It could apply to growth after mergers, or simply act as a rigid limit. Furthermore, what makes this law a sound principle for banks makes it a sound principle for related industries. Why not apply similar market-share caps to investment banks and the insurance industry?

3) Tax law could be used to limit company size. Corporate taxes, which already distinguish between companies based on profits but might also be sensitive to revenue, could be used to further subsidize small companies or penalize large ones. For example, we could enact a radical increase of the corporate income tax for banks above a certain size, or provide subsidies for banks smaller than a certain size. The difficulty with using tax law is that there are often problems with enforcement, and there are fears that tax laws will drive companies out of the US. As a matter of political economy, large firms have been very successful in repealing tax burdens piecemeal and eviscerating the underlying force of tax laws. However, corporate taxation can be a flexible way to respond to the social costs and risks created by companies of different sizes.

4) New congressional laws could support community banks and credit unions, actively encouraging the growth of small and medium-sized institutions. Laws might also pay attention to the ownership structure of banks and other financial institutions, favoring those that, like credit unions, are owned by their customers.

5) Congress and state legislatures should consider more corporate-governance reforms. Last year, the OECD released a report concluding that problems in internal corporate governance played a large role in causing the economic crisis. The problems with corporate governance are complex, but the basic idea is easy to state: corporate managers are willing to take risks with other people’s money that people wouldn’t usually take with their own money. Because managers benefit from corporate growth more than other parties involved in corporations, including shareholders, greater governance-based review of corporate decisions to grow companies may be warranted. For example, laws might change the standard of review for managerial actions that sharply and rapidly grow enterprises, making it easier for shareholders to challenge these actions when they are not in a corporation’s interests.

6) Congress could create stronger presumptions against mergers in the financial sector. Mergers and acquisition are a convenient moment for regulation to intervene, because they often depend on special statutory privileges that allow corporations to combine. We already evaluate mergers in terms of antitrust policy and in a variety of other ways. Reasonable expansions may include requiring greater affirmative shareholder approval to ensure sounder corporate governance, exclusion of mergers between companies larger than a certain size, or even prevention of it by default in certain industries.

A strong competition policy would probably use a blend of these methods, a mix of carrots and sticks, criminal and civil law and tax policy, all reinforcing our vision of a stable, diverse, boring banking sector.

The difficulty with many of these proposals is determining what counts as “size,” and how to measure size in a way that most closely tracks the underlying concerns, without leaving too much room for discretion (and therefore capture) in regulatory agencies. Any scale-based policy will have some unintended side effects, and perhaps, at the margins, have some negative effects. On balance, however, the value of having a stable economy far outweighs the value, often elusive, of having larger concentrated banks.

In the short term, there are some immediate steps that Congress should take, even while considering these broader proposals. In taking over distressed banks, regulators should look to break them up to advance competition-policy aims. For example, if the US does end up taking over Citigroup, it should break it into multiple pieces, ideally creating many decentralized community-based financial institutions. Federal regulators should exhibit a strong bias against shotgun marriages and combinations of banks in distress (e.g., Wells Fargo’s takeover of Wachovia) that significantly contribute to industry concentration. The long-term costs of industry concentration should presumptively outweigh any short-term emergency justifications for merger. Needing to act doesn’t imply needn’t to act dangerously.

Contact:
Shawn Bayern, Assistant Professor of Law, Florida State University
Zephyr Teachout, Associate Professor of Law, Fordham University

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Bank of America: Shareholder Resolutions Adopted by Unauthorized Taxpayer-Shareholder Meeting
A New Way Forward - Bay Area
June 24th, 2009
sanfranciscoanwf@gmail.com


Motion #1: Fire Bank of America's leadership -- Ken Lewis, his top management, and the Board of Directors -- and replace them with new officers.

Over recent years we've seen institutions like Bank of America bring itself and the entire world economy to the brink of ruin through greed, gross mismanagement, and shamefully inadequate risk control. This mismanagement has led to devastating results: approximately 30,000 BofA employees out of work and precipitous loss of shareholder value from $50/share in 2007 to $12/share today. The executives responsible have rewarded themselves with hundreds of millions in pay and bonuses. We therefore need to replace the current leadership with officers capable of protecting the interests of shareholders, taxpayers, employees, and the public.

Motion #2: Break up Bank of America into not less than ten deposit- taking banks that make standard mortgages and small business loans, and not less than ten investment banks for sophisticated rich people to gamble with their own money.

Simple logic demonstrates that if the failure of a single institution causes undue harm to the public good, then the public interest requires that such institutions not be allowed to exist. The only beneficiaries of these "too big to fail" institutions are the top management and the politicians that they influence with campaign contributions and high-paying lobbying jobs.

Motion #3:

As part of this process the good loans and securities will be transferred to the new smaller institutions as per motion #2. The toxic assets will be held by the government in trust and sold back to the private sector over time to minimize losses. The current common stock holders whose lack of oversight contributed to the collapse will bear the brunt of the losses while taxpayer-shareholders and bondholders will be issued shares in the new institutions. This will minimize the ultimate cost to the taxpayer and might result in a gain as the new institutions thrive without the weight of toxic assets and the current mismanagement.

Motion #4: That Bank of America redirect its lobbying efforts from opposing all new government regulation, to supporting regulations that protect the interests of stockholders and taxpayers.

According to official reports, in the first quarter of this year BofA spent $660,000 on lobbying and made $218,000 in campaign contributions. That's an annual rate of $3,512,000 of stockholder/taxpayer money spent to influence the political process. And that's only the reported amounts by Bank of America corporation it does not include amounts by associated entities and individual bank officers. Under the old regulations that were removed by Congress under the Clinton and Bush administrations, bank managers like BofA's Ken Lewis were prevented from taking actions that would line their personal pockets in the short run, but diminish stockholder value and empty taxpayers' pockets in the long run. As stockholders and taxpayers, we want our company to support, rather than oppose, a return to that kind of regulation.




USURY MUST BE RESTRICTED

Donny Shaw


The law against usury should be restored to protect consumers, keep more of working Americans' money out of the financial sector and restrict the kind of subprime lending that contributed to the financial crisis. We need a national cap on interest rates to keep debt from expanding beyond what our economy can actually handle.


Current law allows credit card companies to skirt state usury laws designed to protect their residents by officially incorporating themselves in states like South Dakota and Delaware that have no usury restrictions at all. The state-based system has been essentially moot since 1978, when the Supreme Court ruled in Marquette Nat. Bank of Minneapolis v. First Omaha Service Corp. that state anti-usury laws cannot be enforced against nationally chartered banks "located" in other states.


Since the majority of credit transactions are handled between states, a new federal law must be enacted that supersedes the state system with a nation-wide interest rate cap. Senator Bernie Sanders, for example, has proposed an interest rate cap of 15 on credit cards, except when it is determined that prevailing interest rate levels
threaten the safety and soundness of individual lenders.


Other types of consumer loans, like payday loans and pawnshop loans, must also be addressed. A recent study by the Center for Responsible Lending found that a typical payday loan consumer takes out nine loans per year, meaning that current "reforms" being promoted by Democrats in Congress would amount to annual interest rates of nearly 400 percent. Indeed having borrowers stuck in a cycle of successive loans
is crucial to payday lenders' business models. The same CRL study found that 90 percent of payday lending business is generated by trapped borrowers with five or more loans.


An annual interest rate, somewhat higher than the credit card cap, should be applied to other types of consumer loans. If their business model does not function under a generous interest cap of, say, 30 percent, they should not be in business.




SYSTEMIC RISK REGULATOR
Donny Shaw

President Obama is releasing details of his plan for overhauling the financial regulatory system. It's being widely reported that they were developed with help from the very same people that got us into this mess. Not surprisingly, they won't do anything to address the fundamental dysfunction in our financial system that lets banks grow so big and politically powerful that they they can take down our economy, but still get rescued with money form the taxpayers whose jobs and houses they have put in jeopardy.


The Obama Administration wants to turn the Federal Reserve into the country's financial supercop in charge of deciding when a corporation has become too big to fail and poses a risk to the rest of the economy. Most of Congress, and others like the FDIC's Sheila Bair, are against the idea. They would rather create a new systemic risk council made up of regulators from a variety of agencies, including the FDIC, the SEC, the Treasury, the Fed and others.


Skepticism of the Fed has been growing ever since the economic crisis began. The central bank has been putting up incredible amount of taxpayer money -- somewhere in the range of $4-9 trillion -- in various efforts to stave of the crisis. But, under U.S. code, the Fed is specifically exempted from government audits, so nobody actually knows where any of that money has gone or how much of it taxpayers will be getting back. Compounding the issue is the fact that the Fed, a quasi-government agency, has on its board representatives from all of the country's biggest banks, making it especially ripe for the kind of mind-set corruption that made them blind to the system risks building up in the markets before the meltdown.


The Fed shouldn't be a systemic risk regulator. They don't deserve the power, and neither does any other regulatory council that Congress could dream up.


Why should we think of systemic risk as a subjective question? Why not develop a hard-and-fast set of rules to define a too-big-to-fail bank? If a bank qualifies under the rules, they should be broken up into smaller banks and shareholders should be given shares in the new companies.


Author and former investment banker John Talbott has even suggested some numbers for this. He proposes that any financial company that become "larger than $100 billion in market capitalization, including its debt, or attains greater than $300 billion in assets" should be considered to pose a systemic risk and should be dealt with appropriately. The exact numbers, of course, can be worked out with empirical research. I could see, for example, the cap on size being proportional and adjustable to the size of the financial markets overall.


This kind of scale-based policy has several advantages. First, it promotes competition by keeping financial markets free of monopolistic powers. Second, it would make the financial-services industry more stable by encouraging more small and medium sized banks instead of concentrating power in a few big ones. Third, it precludes unnecessary government meddling in the free market. A fourth advantage, which is actually a feature of the third, is that a hard-and-fast too-big-to-fail rule would keep closed a new avenue for collusion that would be created by a systemic-risk regulator. Giving regulators new power to pick winners and losers among the nation's biggest banks would amplify the pay-to-play system and make government even more responsive to corporate money. Scale-based policies would keep things objective.


There has been a lot of talk among economists recently about regulatory capture as one of the key contributors to the "too big to fail" situation. When making a new policy specifically for dealing with the biggest of the financial corporations -- the ones with the most resources for currying favor with policy makers and regulators -- it just makes sense to construct them so that they are resistant to industry influences.


The idea of a systemic risk regulator is just smoke and mirrors. It's one way of making it sound like they are taking care of root causes of the bailout without having to inconvenience the big banks they've spent the last six months looking out for. No doubt, Obama will or must be pushed to come out with bolder ideas to address root causes. What makes the Obama Administration think that the same people who failed to see any systemic risks before the crisis will suddenly become the nation's foremost experts on the matter just because they have been re-labeled "systemic risk regulators"?




Financial System Reform by William Greider
1. Euthanasia for insolvent banks. Transferring their losses to the public will not restore the trillions in capital the nation has lost and the bankers destroyed. It merely relieves the bankers, their creditors and shareholders of the pain. Govt must step up and take control of the system to supervise a just unwinding of the mess-- whether we call it nationalization or something else. Handing out money and leaving the bankers in control is nutty, also morally wrong. The public understands this. Only Washington does it see the irrationality of what they are attempting.

2. The Fed must be democratized and effectively stripped of its peculiar anti-democratic qualities. A new federal agency -- accountable to elected Congress and elected President -- can be formed with the working parts of the central bank except without heavyweight bankers on the board of directors at 12 regional banks. SEE especially the NY Federal Reserve Bank's board.

3. Because of its gross failure, the reformed Fed would be confined to conducting monetary policy and stripped of its regulatory functions. A different section of Treassury can assume responsiblity for regulations, including strong anti-trust law and other rules that limit and guide financial behavior.

4. The law against usury will be restored. The banking/and financial firms will be stripped of "too big to fail" protection and put on formal notice that at a certain point in their growth banks will be treated as "too big to save." At that point, they will be stripped of all govt protections and subsidies, therefore doomed.

5. A new banking system -- smaller and more diverse and responsible to the public interest-- can arise to fill the hole left by the demise of Citigroup et al. This is where the great public resources should be devoted, not to saving the mastadons. I would add the category of public banks operating as non-profit cooperatives (like North Dakota State Bank) can be an important cross-check on private commercial banking -- a competitve model that offers credit on non-usurious terms and keeps the big boys honest. These would be chartered with special attention to providng financing for small entrepeneurial enterprises that need reliable credit and start-up capital for enviromental innovation and other public priorities. This is the new frontier in finance and cannot wait for conventional bankers to understand its importance to the country.

6. Once the FR is domesticated in a democratic fashion, it must then be reformed to assume broader supervision of the nonbank financial firms in the "shadow banking system," every institution of accumulated capital that does lending and interacts with regulated commercial banks in dangerous ways. Hedge funds, private equity, pension funds mutual fundsetc. See my recent Nation article, "Fixing the Fed " for further explanation of how the Fed failed its duty and how it can repaired with internal reforms.

7. Our first political challenge is to throw logs in the path of Wall Street's "reform" agenda and prevent Congress from again taking hasty action that makes things worse and blocks real reform. The anxious desire of Congress (and probably Obama) is to run a package through quickly and assure the public the whole mess will be taken care of by the cloistered, secretive Federal Reserve and the black box will expend public money beyond public scrutiny.

8. The Federal Reserve is preparing to celebrate its 100th anniversary in 2013. That is the year the Temple should be dismantled or thoroughly transformed, then born again as an authentic instrument of democracy.

Bill Greider March 2009
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