How Banks Became Too Big to Fail

When politicians express outrage toward too-big-to-fail banks, I can't help but laugh a little on the inside. "Wall Street megabanks aren't just too big to fail, they're increasingly too big to jail," vented Senators Sherrod Brown and Chuck Grassley after learning that the Justice Department had opted against prosecuting Wall Street banks for unscrupulous lending practices, illegally foreclosing on homeowners, and laundering money for Iran's Revolutionary Guard and South American drug lords. If you didn't know any better, it'd be tempting to conclude that Brown and Grassley are truly surprised and incensed at the amount of power amassed by a small number of financial institutions. The problem with this interpretation is that it doesn't square with the facts. Banks are too big to fail because we -- or, more accurately, our representatives in Washington with the help of the financial industry's lobbyists -- made them that way.

Over the last 40 years, Americans have been force-fed the notion that oversight of the financial industry was unnecessary because, as then-Federal Reserve Chairman Alan Greenspan put it in 1998, participants in financial markets are "predominantly professionals that simply do not require the customer protections that may be needed by the general public." One year later, Congress voted overwhelmingly in favor of the Gramm-Leach-Bliley Act, which repealed what was left of the Glass Steagall Act's prohibitions against the intermingling of commercial and investment banking activities. "We have learned that government is not the answer," Senator Phil Gramm said at the time. "We have learned that freedom and competition are the answers."

To be fair, the Gramm-Leach-Bliley Act did not cause the financial crisis. It was instead the culmination of a decades-long push to give the nation's biggest banks freer reign. For much of the 20th century, banks were severely constrained in terms of growth. The McFadden Act of 1927 prohibited nationally chartered lenders from establishing branches outside of their states of incorporation. The Banking Act of 1933 (the aforementioned Glass-Steagall Act) separated commercial from investment banking. And the Bank Holding Company Act of 1956 extended the same prohibitions to bank holding companies, which had sprouted to circumvent the restrictions against interstate banking.

Thus, by the early 1970s, it was clear that interstate banking was out of favor from both a legal and political perspective. There was just one problem. A key provision of the Bank Holding Company Act, known as the Douglas Amendment, left a crack in the anti-interstate banking edifice. According to the amendment, a bank holding company located in one state could acquire a bank or bank holding company in a second state if the acquisition was "specifically authorized" by the laws of the state in which the soon-to-be-acquired bank was located. But because no state had enacted such a law at the time it was passed, the Douglas Amendment essentially banned interstate banking altogether. Until 1972, that is, when Iowa decided to do so.

What started as a whimper with a single Midwestern state's decision to allow interstate banking, quickly transformed into the same roar that can be heard today. Multiple states rushed to follow Iowa's lead throughout the 1970s. Alaska, Maine, and Arizona were early adopters, and New York soon followed suit. The trend gained momentum during the 1980s with the introduction of regional banking compacts, which were fueled, in large part, by a U.S. Supreme Court decision upholding their constitutionality. This gave way to the Riegle-Neal Interstate Banking and Branching Act of 1994, which removed all federal impediments to interstate banking and ignited a series of "mergers among equals" that gave us the banking behemoths we know today, including Bank of America (NYSE: BAC  ) and Wells Fargo (NYSE: WFC  ) . And the final piece of the puzzle, the crowning achievement if you will, was the Gramm-Leach-Bliley Financial Services Modernization Act of 1999, which made it possible for the likes of JPMorgan Chase (NYSE: JPM  ) and Citigroup (NYSE: C  ) to take on their present forms.

For investors who weren't cognizant of the changes under way, and particularly throughout the 1990s, it's difficult to appreciate the speed and magnitude of the banking industry's transformation. The closest analogy I can think of is the transcontinental railroad. Within hours of learning about the Supreme Court's decision in 1982, bank CEOs were on the phone arranging interstate merger deals. In 1994, the year Riegle-Neal was passed, only 62 out-of-state branches existed in a small number of states. A decade later, the number had grown to 24,728. And by 1999, Citicorp was so confident in the industry's sway over Washington that it didn't even wait for Congress to repeal the Glass-Steagall Act before violating it by merging with Travelers Group. As the combined company's chairman and CEO Sandy Weill said at the time, "We have had enough discussions to believe this will not be a problem."

Given the economic havoc wreaked by these now-massive and helplessly opaque institutions during the financial crisis, one would be excused for concluding that the epilogue to this story would resemble a return to our pre-1970s ways. But, of course, nothing could be further from the truth. As opposed to acting as an impediment to further consolidation, the crisis ended up being one of its greatest accelerants. In 2008, JPMorgan exploited the turmoil to pick up the nation's fifth largest investment bank, Bear Stearns, and the country's largest savings and loan association, Washington Mutual. Bank of America took over Merrill Lynch, the third largest investment bank, and Countrywide Financial, the largest mortgage originator. And Wells Fargo thankfully succeeded at stealing Wachovia, the nation's fourth largest bank holding company at the time from under Citigroup's nose. And, critically, all of these transactions were completed with the explicit or implicit support of Washington.

The point I'm trying to make is simple: While millions of Americans have lost countless of hours of sleep over the last five years worrying about their jobs and underwater homes, our representatives in Washington have responded with feigned outrage over how things got to where they are today. But as you can see, the reality is, these very same representatives created this problem. Senators Grassley and Brown can lament all day long about banks being "too big to jail," but they both supported the legislation that made them this way. Both sides of the aisle warned about the evils of regulation and proclaimed the virtues of a free market. Republicans spirited the deregulatory measures through Congress, but a democratic president signed them. They allowed themselves to be bought and paid for by the financial lobby. And the financial lobby got what it paid for. Regardless of what you may or may not believe, the nation's largest banks are too big to fail and will remain so until Washington genuinely decides otherwise.


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  • Report this Comment On April 24, 2013, at 12:57 PM, HenryMac wrote:

    Grassley and Brown are running another scam. Their "too big to fail" bill serves one purpose only, which is to preempt efforts to restore the Glass-Steagall Act, the one thing which would actually make a difference. With banks, size is not really the issue: it is function. We need legitimate commercial banks that make loans, not gambling banks (of whatever size.) The House has HR 129 to restore Glass-Steagall, and what is needed is a Senate version of that bill.

  • Report this Comment On April 24, 2013, at 5:26 PM, damilkman wrote:

    How about the next tie the banks get in trouble with a speculative bubble the government just does not bother to bail them out. No need for hard to pass laws. They are just gone. Is that not worth taking our lumps? Someone just has to have the guts to do it.

  • Report this Comment On April 25, 2013, at 5:52 PM, Scoot411 wrote:

    BINGO damilkman! If these banks would've been left to die back in the fall of 2008 they wouldn't be pulling the crap they pull now because there's no fail safe for them. Meanwhile, the working folk wouldn't have to worry about getting taxed to death to pay for their BS. The bad financial institutions would've died off.

  • Report this Comment On April 25, 2013, at 5:57 PM, xetn wrote:

    None of the above nonsense could have taken place with out the Fed and FDIC as the back-stoppers. They allowed the moral hazard to take place with the ultimate knowledge that they would be bailed out.

    We don't need regulations, what we need is the removal of the the back-stoppers. If the bankers still wish to take outlandish risks, then they would be forced to accept the responsibility and fail!

    Those same back-stoppers is what also helped those TBTF banks to grow without investments. When a "small" bank failed, their assets (not their liabilities) were given to the larger banks and the liabilities were given to the taxpayers.

  • Report this Comment On April 25, 2013, at 6:16 PM, dgmennie wrote:

    "[Repblicans and Democrats alike] allowed themselves to be bought and paid for by the financial lobby. And the financial lobby got what it paid for. Regardless of what you may or may not believe, the nation's largest banks are too big to fail and will remain so until Washington genuinely decides otherwise."

    Obviously, what voters want from Washington is ignored while the lobby groups hold nearly full sway. Nothing significant can change so long as this situation is not resolved in favor of voters. But how do you rip the present US Governent apart and create something that MUST respond to the electorate? It is now simply too difficult to crush the vested interests and remove the folks who make a careeer out of elected office. Our democratic system, that (in theory) should self-correct, now stinks. What is the solution? I don't know. But I do know that any proposals bound up in existing practices featuring incremental changes with timelines measured in decades WILL NOT WORK

  • Report this Comment On April 25, 2013, at 6:21 PM, borneofan wrote:

    Had we let GM and BofA sink beneath the waves as they so richly deserved, too big to fail would not be part of the political discourse. The language and the country are poorer as a consequence.

  • Report this Comment On April 25, 2013, at 6:42 PM, maccdw wrote:

    Sadly, dgmennie is correct (above). “It is now simply too difficult to crush the vested interests and remove the folks who make a career out of elected office. Our democratic system, that (in theory) should self-correct, now stinks.”

    While it is illegal for me to coerce your vote as an individual, it is perfectly legal for narrow interests (banking lobbyists) to coerce the votes of our elected reps. Until (as in, never gonna happen) we prohibit such coercion, it is simply a lost opportunity. Money wins, period.

    The Golden Rule: He, who has the gold, makes the rules.

  • Report this Comment On April 25, 2013, at 9:23 PM, solyom wrote:

    The little country of Iceland can teach the world how to handle a banking crisis. In Jan of 2008 the Krona began to fall; by September the main three banks of Iceland were in danger of bankruptcy. The officers of the banks were indicted; here Robert Rubin was rewarded with 110 million for allowing his bank to lose 90% of its capitalization; before Charles Keating of credit union infamy went to jail. The government allowed limited withdrawals in person; the sections of the banks that took excessive risks were closed.

    But in Iceland difficult questions are often decided by popular vote (true democracy); the people of Iceland generally accept responsibility of their vote.

    Link: http://en.wikipedia.org/wiki/2008%E2%80%932011_Icelandic_fin....

    They were willing to accept a 90% loss of the equity mkt.

  • Report this Comment On April 25, 2013, at 10:01 PM, foxhop1 wrote:

    Occasionally, courageous politicians do arise to tackle intractable problems. Teddy Roosevelt broke the trusts, and the multiple companies created further wealth for shareholders -- just as multiple baby Bells multiplied wealth for the shareholders of the old AT&T.

    Who would want to invest in Bank of America today? As you point out, it's opaque, and even the management could never understand exactly what toxic assets lie beneath the covers. It's impossible to lead because it runs in too many directions and it has a culture of frightened, mostly mediocre people who would leave in a minute if they could. BofA and other lumbering banks should be busted up for the benefit of shareholders -- as well as for customers who suffer at the hands of anti-entrepreneurial bureaucrats.

  • Report this Comment On April 25, 2013, at 10:09 PM, rmondave2 wrote:

    We are in a quagmire, the US has been weakened by corruption at all levels, from the local politicians to the Feds.. Changes will be made only once the system (banking and monetary) fails.

  • Report this Comment On April 25, 2013, at 10:19 PM, Anishinabe wrote:

    This is a small problem in the light of the greater

    swindle, but people with family trusts in small local banks suddenly found themselves owned by a larger bank and then a still larger bank, evolving to ownership by ever more gigantic banks.

    The very low fees of small local banks began to grow in accordance with the new owners. Trust officers pressured beneficiaries--those of them

    who had refusal rights--to let the trust departments buy and sell as they saw fit, increasing their fees and commissions. Grandfather trusts that once seemed secure for grandchildren no longer seemed safe. They seemed oriented towards benefitting banks.

  • Report this Comment On April 25, 2013, at 10:48 PM, whahoppened wrote:

    foxhop1, good observation. If you've been watching, the baby bells under Southwestern Bell have been quietly re-assembling themselves, re-named themselves AT&T and are positioning themselves to run every one else off!

  • Report this Comment On April 26, 2013, at 1:00 AM, burrowsx wrote:

    How silly. Banks and corporations are bigger today because Ronald Reagan thought the US would be better able to compete globally if we imitated the economy of Japan. So he virtually dismantled anti-trust prosecution, allowed almost unlimited horizontal and vertical mergers, and began work to dismantle banking regulations.

    We all see today where this ended for Japan, but Republicans and their media empires continue to tout Reagan, and his deregulation as the road to prosperity. The involvement of legislators is an epiphenomenon of money flow. The proximate cause of too big to fail, is allowing corporations to be too big and too diverse to govern.

  • Report this Comment On April 26, 2013, at 2:00 AM, chefdd wrote:

    If nothing has been fixed, what do the more knowlegable persons (i am not one) of this forum think will eventually happen? What is the time frame for this? What is the best way to protect money, that I have worked my a** of as a caterer, with my blood and sweat and tears?

  • Report this Comment On April 26, 2013, at 8:20 AM, ziq wrote:

    What this summary of recent history says to me is that we don't need fewer regulations, or even more regulations. What we need is *the right* regulations. When they start having unintended negative consequences they need to be fixed.

    To acheive that end it would help to eliminate pay to play access to government digsuised as "campaign contributions". But I don't see that happening any time soon.

  • Report this Comment On April 26, 2013, at 8:30 AM, ziq wrote:

    @burrowsx :

    It's also silly to blame Reagan. Even "the Great Communicator" did not rule by fiat. It's similarly silly for partisans of the other flavor to blame Clinton for repealing Glass-Steagall. The Congress wrote the bill, Clinton signed it. The article does not say whether they "voted overwhelmingly" to repeal it by a veto-proof majority, but even if they didn't, it's well known parties and presidents horse trade for legislation they want all the time. It took team work to muck things up this badly.

    If there's one simple culprit it's the ability of corporate interests to write their own ticket.

  • Report this Comment On April 26, 2013, at 9:48 AM, Gorm wrote:

    We have cause to WORRY! The top 6 financial behemoths control > 50% of US domestic deposits. Our FDIC maintains maximum reserves equal to 1.25% of insured deposits. When depleted, it draws on our Treasury.

    Business STILL complains that access to credit is a major issue. Banks are NO LONGER forced to lend to earn. With elimination of Glass Steagall the financial behemoth were GIVEN a whole new source of FEE income, decreasing their reliance on spread.

    Banks have NOT learned. Look at JPM, ie London Whale, LIBOR manipulation, growth of derivatives, lobbyist emphasis on watering down restrictions, controls, etc. And how has poor behavior hurt any financial, any CEO? Just WHO is accountable?

    From my perspective the KEY change driver was the switch from defined benefit to defined contribution plans, where financials WERE compelled to increase EPS, ROA, ROI to appease analysts, leverage their options, hype personal earnings.

    Gorm

  • Report this Comment On April 26, 2013, at 11:49 AM, livtwoski wrote:

    Well, the situation is more 'dire' than all the comments that cry over 'spilled milk' - as it were.

    We need to break up large banks for several reasons - one of which is to mitigate societal risk and, also, because the economies of scale for banks simply do not translate into efficiencies for the rest of the market.

    There have been several reasoned economists (non partisan driven economists) who have artculated the value in a 'too big to fail' dissolution. This should be our first priority and ANY changes to the current laws absent that is merely the painting of lipstick on a pig.

    Lastly, there have been NO significant changes to the regulation of the derivative(s) market. And, rest-assured, if the derivatives market were to collapse there is NO person who can say with certainty there would not be a cascading effect within the market - nor where that first domino might fall because nobody truly can dissect where the investments are placed. If Warren Buffett said he tracked investments back 30+ layers and was still unable to figure out what was going on...well, that's good enough for me to say, as he did, they're not good things to without regulation.

    Unfortunately, too many people profit too much (including politicians) to change anything for we, as those interested in the markets (and hopefully our country) have little - if any - say. Soooo the next time there is a 'global melt-down'.rest assured there will be no capacity to bail any of us out...barring the banks.

  • Report this Comment On April 26, 2013, at 12:45 PM, OldFool2325 wrote:

    While I agree with most of the sentiments expressed, it is important to note that interstate banking is not the problem. It is both extremely useful, even necessary, for personal and business use, and was inevitable with the rise of credit cards. The real problems were the intermingling of banking and investment and the opacity and inability and unwillingness to regulate the new impossible to understand investment paper created on Fraud Street.

  • Report this Comment On April 26, 2013, at 12:47 PM, mrTpitiesMe wrote:

    Clowns are oblivious to everything. That is what makes them so amusing to watch. In my day job, I get to watch actuaries/economists/meteorologists/professors get paid by the US government to pretend this or that proposal makes sense. The result is a thousand fold money-damage to some or other target. It is dumbfounding how fast a "hyper-aware scientist" will turn into a Clown for one million dollars. This is the debasement of us, by us, for easy money. I have a pet theory debasement happens more frequently during recessions. However, I'm a Fool; it doesn't matter what I think.

  • Report this Comment On April 26, 2013, at 1:50 PM, lm1b2 wrote:

    Big banks became to big to fail when the DOJ refused to prosecute The Wall Street Thieves for the biggest fraud ever committed on the American people, sending us into the biggest recession since the Great Depression !Now our Financial institutions have a green light to steal at will,without fear of Criminal Prosecution,protected by our Federal Government no less !

  • Report this Comment On April 26, 2013, at 3:13 PM, dsmoyer1 wrote:

    This all began with the "implicit" guarantee associated w FANNIE MAE and FREDDIE MAC in 1938 and 1970. Without these two government "sponsored" entities the housing bubble never forms and banks could not have grown as large as they are today. Speaking of too large to fail, your government has done a wonderful job of deflecting the blame to the private sector, as usual. The two largest villians in this long lineup of villians are FANNIE and FREDDIE.

  • Report this Comment On April 26, 2013, at 5:55 PM, dmiles2 wrote:

    Lobbyists would not get much traction if Senators and Reps had integrity. The crime is not in asking for favors from government; the crime occurs when legislators write and pass laws that favor one business or region or even individual over the rest.

    The reason big money is even interested in going to Washington is because our 'representatives' are whores who can be bought.

  • Report this Comment On April 27, 2013, at 1:06 AM, JCoeur wrote:

    This article seems to assume that too big to fail represents reality. Isn't it possible that 6 years later, if we had let those guys fail in 2007-2008, we would be in pretty good shape by now?

  • Report this Comment On April 27, 2013, at 1:08 AM, JCoeur wrote:

    What's really too big to fail is the public's trust and confidence in their government. But it is failing.

  • Report this Comment On April 27, 2013, at 1:10 AM, JCoeur wrote:

    Too big to fail is one thing. Now our Attorney General has acknowledged before Congress a policy of Too Big to Jail for the management of these institutions. And Congress, knowing who controls the campaign coffers, didn't bat an eye.

  • Report this Comment On April 27, 2013, at 3:46 PM, ChrisBern wrote:

    +1 JCoeur. Until we're willing to suffer short-term pain in order to have long-term stability, we're going to continue to have emergency crises with emergency "must-have" bailouts for TBTF banks, manufacturers, etc.

    Of course the horizon problem is a major issue here, given that politicians get elected in the short-term whereas the healthy of a country's economy is decidedly long-term.

  • Report this Comment On April 28, 2013, at 8:51 AM, hembreeder wrote:

    Correct me if I'm wrong, but didn't the community redevelopment act have something to do with the banks getting into really bad shape? I was under the impression that the banks came up with their strange and overvalued housing investments to get rid of bad loans. And many investment houses over-levereged these bad loans to great excess.

    The banks, uncer the law, had to make loans without bias against people who could not pay the laons back. The politicians believed it would be OK to transfer most of these bad laons to Fannie Mae and let the taxpayers buy the houses for people who could not be expected to ever make a payment.

    Many bankers objected strenuously, and many of them were fired when the SEC began to halt mergers and take other punitive actions against balky banks.

    The the politicos to their way, apparently. The got taxpayers to pay for the bad loans, and banks lied about the value of the financial instruments and got S&P and other rating agencies to give AAA ratings to the bad mortgage packages.

    That was my take on what happened leading up to the mortgage crises, which is still unwinding slowly because we are still following those very same policies and tring to restart mortgages time after time for people just aren't paying and never will.

  • Report this Comment On April 28, 2013, at 8:57 AM, hembreeder wrote:

    I would add that there is apparently a controlling principle here: Need always will exceed wealth. Don't believe me? Look at how tiny Greece has shown the capacity to take down Europe. What a perfect example. Germany has been hurt badly. There are always hidden weaknesses. These become fatal flaws. Upheaval can ensue.

  • Report this Comment On April 28, 2013, at 11:25 PM, adics11 wrote:

    That is a our great country. Our politicians are corrupt

    And they are becoming wealthy by many means. Citizen of US has no control. We call it democracy.

    We worship our past great leaders. What a mess we are in so bad we cannot and will never be able to fix it. And it is worldwide weather it is democracy, dictatorship or communist regime. Our leaders are not ashamed of inside trading and we cannot even make them responsible legally. For votes they are making illegal immigrants legal. They will do anything for money.

  • Report this Comment On April 29, 2013, at 3:42 PM, Thaeger wrote:

    The greatest problem with our political system is the amount of money it takes to get/stay elected. Politicians are forced to make so many promises to so many wealthy donors that their positions on any given issue are seldom motivated by with what mere voters might want.

    To put some numbers to this: ( http://www.bbc.co.uk/news/magazine-19052054 )

    “New figures just released by the Center for Responsive Politics, an independent research group which tracks money in politics, estimate the total cost of November's elections (for the presidency, House of Representatives and Senate) will come in at $5.8bn (£3.7bn) - more than the entire annual GDP of Malawi, and up 7% on 2008.

    (Projected spending estimates for 2012 US elections:

    • Total cost - $5.8bn (£3.7bn)

    • Presidential election - $2.5bn (£1.6bn)

    • Super Pacs and other outside groups - at least $750m (£480m)

    It makes UK election spending look microscopic by comparison. A total of £31m ($49m) was spent by all parties in the last general election in the UK two years ago - making US spending 120 times as much, and 23 times as much per person...

    ...It could hardly be more different in the UK where airtime for campaign ads is free - indeed you not allowed to buy it - and tightly limited. In the last general election, the two main parties were allowed four or five party political broadcasts each in England, and six between Scotland and Wales - compared to hundreds of thousands of ads in the US...”

    ===

    I know, to each his own and all that...just, plenty of other folks have managed to squeeze a little common sense into the mix without creating a socialist/Orwellian/etc wasteland in the process; and while getting the money out of politics wouldn’t solve our problems overnight, it is an achievable goal, and would certainly eliminate one helluva headwind to mending our political system.

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