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Flipping the Bird at Too Big to Fail

Is it too much to ask the biggest too-big-to-fail banks to refrain from getting bigger than they already are?

Apparently. In just the past week, consider:

  • Citigroup (NYSE: C  ) declared in an investor presentation that it'll grow core managed assets -- already $1.4 trillion deep -- by 5% annually going forward. That might not sound like much, but if the economy grows by 2%-3% per year while Citigroup grows by 5%, it piles on more systemic risk by the day. If that wasn't enough, Citigroup is also looking to beef up its proprietary trading unit, according to Bloomberg.
  • JPMorgan Chase (NYSE: JPM  ) just signed a deal to purchase the commodities trading division of RBS Sempra. This is just weeks after President Obama decried taxpayer-backed commercial banks for engaging in such activities and proposed new laws to ban them from doing so.

How's that for disregard? Take your too-big-to-fail risk and shove it!

Fingers crossed ...
Something's gotta be done about too big to fail. Sooner rather than later would be cool, before the meltdown of 2008 fades from memory. Yet the folks tasked with overhauling this mess have shown frightening glimpses of disregard.

Before new financial reform rules were proposed in January, the White House gave a background briefing to a group of journalists and analysts. When discussing ways to rein in banks' size, a White House official noted that we already have a size rule. It's known as the 10% rule -- a 1994 law that prevents banks from making acquisitions that push them over owning 10% of the nation's deposits. "Under our system today," the official noted, "there's a cap on deposits that prevents future acquisitions by a firm if they're up against that cap or if the acquisition would place them over the cap." To go further, the White House proposes expanding the rule from deposits to other forms of funding, like short-term debt.

That's a great start. Really. But associating a new too-big-to-fail solution with the deposit rule makes it about as promising as most first-round American Idol contestants. The current rule is spineless at best, with mile-wide loopholes that banks can stride through without breaking a sweat.

Over the past 18 months, two banks made deals resulting in ownership of more than 10% of the nation's deposits. Bank of America (NYSE: BAC  ) , which controlled 11.8% after buying Merrill Lynch, and JPMorgan Chase, which owned 10.2% after buying Washington Mutual, according to SNL Financial.

How'd they bypass the rule? It was really just a matter of semantics. The 10% rule specifically applies to banks acquiring banks. But neither Merrill Lynch nor Washington Mutual technically fit that bill. Merrill Lynch was a broker-dealer; Washington Mutual was a thrift. So they were free to merge and create two of the largest and most hazardous financial monsters the world had ever known. A rule that can be circumvented that easily loses its significance pretty quickly.

Another effort to end too big to fail is proposed "resolution authority" that lets regulators seize and break up a bank if it's about to fail and wreak havoc. This, JPMorgan Chase CEO Jamie Dimon tells us, "can help halt the spread of one company's failure to another and to the broader economy."

Well, OK. But resolution authority might as well be called the "if it's broke, don't fix it" approach to problem solving. Allowing a bank to become preposterously large and entangled but giving the government the go-ahead to take over and wind it down is exactly what regulators did with AIG (NYSE: AIG  ) , Fannie Mae (NYSE: FNM  ) , and Freddie Mac (NYSE: FRE  ) . Can't wait to relive those memories! It's really simple: These rules must be preventive, not reactive.

Buck up and get the job done
What you need to truly end too big to fail are firm laws that say, "Look, a financial company can't be larger than X, period. If you're bigger than that, sell assets or break yourself apart. If you're thinking about doing a deal that makes you bigger than X, go pound sand. And we don't care what jargon you use to dissociate yourself from the word 'bank.' If you're in the business of money, these are the rules you'll follow."

There's no excuse not to do this, and hardly a rational argument against it. Very few politicians and regulators, though, are brave enough to even talk about it.

So why don't we talk about it more? What do you think should be done to stop too big to fail? Let us know in the comment section below.

Be sure to check back every Tuesday and Friday for Morgan Housel's columns.

Fool contributor Morgan Housel doesn't own shares in any of the companies mentioned in this article. The Fool has a disclosure policy.

Read/Post Comments (17) | Recommend This Article (35)

Comments from our Foolish Readers

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  • Report this Comment On March 19, 2010, at 11:08 AM, Brickguy wrote:

    "Citigroup (NYSE: C) declared in an investor presentation that it'll grow core managed assets -- already $1.4 trillion deep -- by 5% annually going forward. That might not sound like much..."

    But which sound like much?

  • Report this Comment On March 19, 2010, at 11:14 AM, yettry wrote:

    It will fail quickly...

  • Report this Comment On March 19, 2010, at 11:29 AM, pmlang37 wrote:

    You are right on!

    Government regulators are hopelessly unreliable and slow working after the fact in a crisis. Breaking them up before the crisis is the only right thing to do.

  • Report this Comment On March 19, 2010, at 11:32 AM, janiceodell wrote:

    The banks clearly own Congress. So the behavior won't change until the campaign contributions end.

  • Report this Comment On March 19, 2010, at 11:41 AM, questioner5000 wrote:

    You're absolutely right! JPM shouldn't have been allowed to take over Washington Mutual. Third National Bank in Podunk, Alaska, with a highly localized network of five branches, would have been a better choice to take over the complex, multi-faceted, nationally disbursed Washington Mutual network, because, after all, it would have kept JPM from going over the "magical" 10% limit by two whole tenths of a percent!

    And those sneaky bastards at BAC! Taking over Countrywide and Merrill Lynch, to increase their share to over 11% of the nation's deposits! They should have been prohibited from these devilish takeovers, and the problems should have, instead, been dumped on the government and taxpayers. The FDIC could have handled all of the Countrywide unwinding, (and accepted liability for all of the lawsuits being filed against Countrywide), like BAC is stupidly doing! And that "clever" ML acquisition... BAC should have been prohibited from purchasing ML when it did, (and ruining its shareholders for years to come), and ML should have been allowed to go the way of Lehmann, thus bringing on the collapse of MS and even GS, as well as much of the U.S. and even global financial system!

    But, what was more important at the time - - the health of the global economy, or keeping BAC below the "magical" 10% number?

    Of course, to lower their percentage of national deposits, they could close some branches! The again, if BAC even tries to close some of its most unprofitable branches, (such as those they acquired from ABN-Amro in Detroit, as part of their purchase of LaSalle Bank, or some of those in South Central L.A.), they'd come under enormous political pressure, be subjected to acrimonious name-calling by the likes of Maxine Waters, and lose their presently high CRA rating.

    Well, they could also lower their percentage of national deposits by offering even LOWER rates to their deposit customers, chasing their current clients to other banks! Of course, that might work against the governments conflicting guidance to raise their capital ratios while vastly increasing their loan activity.

    The fact is, without the "too big to fail" commercial banks like JPM, BAC, and WFC to help the government clean up the latest mess, we'd surely be in a DEPRESSION at this time. So, let's give the "too big to fail" banks a year or so to get back under the 10% cap, without ranting about it at the present time, O.K.?

  • Report this Comment On March 19, 2010, at 1:40 PM, BMFPitt wrote:

    Step 1: STOP ASSISTING BANKS AT BECOMING TOO BIG [for the spineless, financially illiterate Congress of ours to allow] TO FAIL

  • Report this Comment On March 19, 2010, at 2:40 PM, DJDynamicNC wrote:

    This sums it up, really. When US assets are firmly locked up in three banks and China, can you even call it capitalism anymore? There's nothing free about markets controlled by four people in a boardroom.

  • Report this Comment On March 19, 2010, at 3:11 PM, TMFTomGardner wrote:

    DJDynamicNC, terrific comment, succinctly put. The question we need to begin asking is -- what can be done about this before the financial reform wagon rolls out of town? This article and your comment present a perfect start.

  • Report this Comment On March 19, 2010, at 4:55 PM, questioner5000 wrote:


    You wrote; "When US assets are firmly locked up in three banks and China, can you even call it capitalism anymore?"

    First of all, if you add up the deposits held by the three largest US banks, you come up with about 28% of national deposits. Add on the next 10 banks, and I doubt you break 45%. (Deposits were more concentrated during the "crisis", when there was a flight to the bigger banks and money was withdrawn from the stock market.) That is hardly a case of over-concentration. For, you see, no other major country has as fragmented a banking system as does the US.

    Canada does just fine with its 5 major banks. France and Germany are the same way. The same is true in most countries around the rest of the world.

    So, why not tone down your "hyperbole" about "the end of capitalism as we know it".

  • Report this Comment On March 20, 2010, at 2:04 AM, dinobaba wrote:

    While we're on the topic of "the end of capitalism as we know it" (thanks DJDynamicNC), I want to pitch in an opinion. For a long time (the industrial age) our system has been biased in favor of large, mass production, economy of scale economics which has served us well in the US since we had the biggest unified economy/market, but I would say for the benefit of efficiency, and productivity, we have sacrificed craftsmanship, art, quality, and beauty. I think it is time for us as a nation to shift the bias toward a smaller scale "Mom and Pop" style economy, and leave the assembly lines to China. Just an opinion.

  • Report this Comment On March 20, 2010, at 3:41 AM, dinobaba wrote:

    Since we're on the topic of "the end of capitalism as we know it" (thanks DJDynamicNC) I just wanted to pitch in an opinion. For a long time (The Industrial Age) our system has favored the large, mass production, assembly line type system, which has served us well in the US, since we had the largest economy/market. But in the name of productivity and economy of scale (not bad things) we have sacrificed craftsmanship, quality, art, and beauty and even okay, I'm sticking my neck out here, our individual autonomy and merit. I propose that it is time for us, as a nation to shift our bias toward the small scale "Mom and Pop" and "craft" type enterprises and leave the assembly lines to China.

  • Report this Comment On March 20, 2010, at 7:44 AM, Aristocrisis wrote:

    Yeah, it all sounds like common sense. The problem is that the whole system favours "the status quo", meaning more to the largest and fattest dogs.

    The reason why the big banks want to stay that way, is it gives them clout to influence the politicians(remember the sudden ban on shorting financial shares?), to own the FED, and keep on paying themselves enormous salaries. It also gives them the option of making the taxpayer pay for their mistakes.

    It's a Goliath's world out there. Nice to try and make some debate about it.

  • Report this Comment On March 20, 2010, at 7:53 AM, Aristocrisis wrote:

    Capitalism in the US has a tendency to become monolithic and concentrates power in a unprecedented way. You'd need someone from outside (the political system) to make a change here.

    Obama's overhaul of credit-card companies is good, but it should only be a start. It's nice to see someone with guts in charge, I hope he doesn't underplay his hand.

  • Report this Comment On March 21, 2010, at 7:40 AM, pikerun2000 wrote:

    Obama couldn't run a snow cone stand in the middle of the summer on 42nd street and make money

  • Report this Comment On March 27, 2010, at 12:38 AM, RB62 wrote:

    The reason politicians will never get serious @ clamping down on risky actions by any big business is because what does a politician do when they finally leave office or booted out?

    Is go run big business! So it like the old saying don't bite the hand that feeds you.

    Until more people make an informed decision on who they vote for & why!

    We will continue to be plagued w/ bad politicians world wide.

    They're our employee's & we should hold them accountable for all they do?

  • Report this Comment On April 03, 2010, at 5:05 PM, ObscuredVision wrote:

    The pure contempt for the laws of the land as stated by at least 2 congressmen in the last two weeks ('There are no laws, we make them up as we go along') certainly makes the case for throwing them out. But who would take the time away from TV to study the alternative candidates? What information can you believe? To make a sound judgement would be at least a 20 hour a week job. What decent, moral, and sane person would want to fight tooth and nails to run for office and go to DC and be whizzed on and eviscerated by the Nancy Pelosi's, Reed's, Obama's, and the rest who don't have any restraint on how they play the game. No matter, if you are decent, honest, and forthright, you don't have a chance of getting elected. Most of congress isn't any different than the bankers. Face it - The Genghis Kahn's of the world still rule and I don't have a clue as to how to effectively change it. The power of congress has to be restrained - How do you do that?

  • Report this Comment On April 15, 2010, at 1:48 AM, eekthecat wrote:

    dinobaba, I agree. Ever since I was a child I've always associated America with low quality and low integrity. Just compare "American cheese" to any other cheese. And I would never buy a modern house, made by one of these homebuilder corporations; they seem so fake and cheap and devoid of character.

    We always look for growth just in terms of numbers, but forget that improvement is also growth. We've mastered the art of making massive amounts of things; what we need to do now is relearn how to make better things.

    And this is a good time to get people to realize that, because the recession should make a lot of people realize that they've been being sold a lot of nonsense. Worthless CDOs are somewhat of a metaphor for a lot of the crap that was being sold. We could fix this economy by shifting a greater focus towards making--and buying--things which are actually worth paying for.

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