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.

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