The Obama administration is on the verge of rolling out a series of new regulations to prevent a repeat of the still rampaging financial crisis. But it’s not enough for policy makers to simply propose expanding the Federal Reserve’s enforcement power, or putting forth new rules for regulating derivatives, exotic securities and hedge funds.
What’s needed now more than anything, is a plan to ensure that no financial institution is ever again “too big to fail.’’ The seemingly endless bailouts of American International Group(AIG), Citigroup(C)and Bank of America (BAC)are all premised on the fear that if any one of these financial services giants were to fail, the global economic fallout would be catastrophic. And as distasteful as it may be, regulators and policy makers are correct that there’s no other choice than to save these firms.
But once these financial behemoths no longer pose a systemic threat, they need to be dismantled and dramatically shrunken. And the same must go for banks that aren’t on the critical list. So far, JPMorgan Chase & Co. (JPM)has managed to avoid becoming a financial basket case like Citi or Bank of America. But the world economy cannot risk a situation where some future crisis puts JPMorgan on the edge of disaster. If that means forcing relatively healthy banks to get smaller—either through voluntary divestures or old-fashioned trust busting—so be it.
There’s precedent for putting constraints on the ambitions of US banks. Federal rules have long restricted any one bank from controlling more than 10% of the nation’s customer deposits. Maybe there should be a similar restriction on the dollar value of derivatives contracts that a bank can enter into. A cap on the number of off-balance sheet special purpose entities a bank can create might be worth considering too. A limitation on the number of nations a bank can operate in also might be worth a look.
Some will argue that these restrictions are anticompetitive and will put US banks at a disadvantage to foreign competitors. That may be so. But the current crisis has shown that the threat posed by megabanks—especially when they mess up—is simply too great for all of us to bear.