Clients and others who have attended our seminars and read our publications know that we have for years railed against the existence of "too big to fail" (TBTF) financial institutions. Since the 2008 near-meltdown of the financial system, world governments and central banks have unrelentingly kept alive even the most moribund of the world's big banks.
In the majority of developed countries, there exists an article of faith that life as we know it cannot survive without resident financial giants in robust condition. In recent years, that conviction has resulted in multi-billion dollar rescues and the availability of a flood of nearly free money with which to bolster balance sheets and income statements. Senior executives in these government-supported enterprises have rewarded themselves with pay packages unknown through history but to kleptomaniacal dictators or founders of vast corporate empires. Besides providing relatively pedestrian traditional banking services, these entities have made their mega-bucks by structuring and peddling securities, some of which were instrumental in triggering recent financial crises. Such inequity has to be particularly galling to people whose efforts are providing real benefit to humanity.
Finally emerges an ironic but powerful ally in the fight against TBTF. The Federal Reserve Bank of Dallas devotes its 2011 Annual Report to that end. Titled "Choosing the Road to Prosperity: Why We Must End Too Big To Fail - Now," the report presents a cogent, straightforward argument against the existence of giant banks.
Reading the entire report will serve up the meat of the argument, but the following quotes will offer some of the flavor.
In his introductory letter, Dallas Fed President Richard Fisher made the following points:
"More than half of banking industry assets are on the books of just five institutions. The top 10 banks now account for 61 percent of commercial banking assets, substantially more than the 26 percent of only 20 years ago; their combined assets equate to half of our nation's GDP."
"In addition to remaining a lingering threat to financial stability, these megabanks significantly hamper the Federal Reserve's ability to properly conduct monetary policy. They were a primary culprit in magnifying the financial crisis, and their presence continues to play an important role in prolonging our economic malaise."
"The lackluster nature of the recovery is certainly the byproduct of the debt-infused boom that preceded the Great Recession.…"
"The TBTF institutions that amplified and prolonged the recent financial crisis remain a hindrance to full economic recovery and to the very ideal of American capitalism. It is imperative that we end TBTF. In my view, downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response."
Harvey Rosenblum, the Dallas Fed executive vice president and director of research, wrote the body of the report. Several of his contentions follow.
"As a nation, we face a distinct choice. We can perpetuate too big to fail, with its inequities and dangers, or we can end it. Eliminating TBTF won't be easy, but the vitality of our capitalist system and the long-term prosperity it produces hang in the balance."
"If allowed to remain unchecked, these entities will continue posing a clear and present danger to the U.S. economy."
"Moral hazard reinforces complacency. Moral hazard describes the danger that protection against losses encourages riskier behavior. Government rescues of troubled financial institutions encourage banks and their creditors to take greater risks, knowing they'll reap the rewards if things turn out well, but will be shielded from losses if things sour."
"The Fed kept interest rates too low for too long, contributing to the speculative binge in housing and pushing investors toward higher yields in riskier markets. Congress pushed Fannie Mae and Freddie Mac, the de facto government-backed mortgage giants, to become the largest buyers of these specious mortgage products. Hindsight leaves us to wondering what financial gurus and policymakers could have been thinking."
"Mammoth institutions were built on a foundation of leverage, sometimes misleading regulators and investors through the use of off-balance-sheet financing. Equity's share of assets dwindled as banks borrowed to the hilt to chase the easy profits in new, complex and risky financial instruments. Their balance sheets deteriorated-too little capital, too much debt, too much risk." (What would the Dallas Fed say about the Fed's own balance sheet?)
"With size came complexity.…Complexity magnifies the opportunities for obfuscation.…They pushed the limits of regulatory ambiguity and lax enforcement. They carried greater risk and overestimated their ability to manage it."
"The term TBTF disguised the fact that commercial banks holding roughly one-third of the assets in the banking system did essentially fail, surviving only with extraordinary government assistance."
"While reducing the interest burden for borrowers, monetary policy in recent years has had a punishing impact on savers, particularly those dependent on shrinking interest payments."
"The machinery of monetary policy hasn't worked well in the current recovery. The primary reason: TBTF financial institutions. Many of the biggest banks have sputtered, their balance sheets still clogged with toxic assets accumulated in the boom years."
"The rationale for providing public funds to TBTF banks was preserving the financial system and staving off an even worse recession. The episode had its downside because most Americans came away from the financial crisis believing that economic policy favors the big and well-connected. They saw a topsy-turvy world that rewarded many of the largest financial institutions, banks and nonbanks alike, that lost risky bets and drove the economy into a ditch. These events left a residue of distrust for the government, the banking system, the Fed and capitalism itself."
"Capitalism…requires maintaining a level playing field. The privatization of profits and socialization of losses is completely unacceptable. TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and powerful."
"[T]he country must find a way to ensure that taxpayers won't be on the hook for another massive bailout."
"It could be argued that zero interest rates are taxing savers to pay for the recapitalization of the TBTF banks whose dire problems brought about the calamity that created the original need for the zero interest rate policy."
"Disciplining the management of big banks, just as happens at smaller banks, would reassure a public angry with those whose reckless decisions necessitated government assistance."
"Big banks often follow parallel business strategies and hold similar assets. In hard times, odds are that several big financial institutions will get into trouble at the same time. Liquid assets are a lot less liquid if these institutions try to sell them at the same time. A nightmare scenario of several big banks requiring attention might still overwhelm even the most far-reaching regulatory scheme. In all likelihood, TBTF could again become TMTF-too many to fail, as happened in 2008."
"The TBTF survivors of the financial crisis look a lot like they did in 2008. They maintain corporate cultures based on the short-term incentives of fees and bonuses derived from increased oligopoly power. They remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation. Just as important, their significant presence in dozens of states confers enormous political clout in their quest to refocus banking statutes and regulatory enforcement to their advantage. The Dallas Fed has advocated the ultimate solution for TBTF-breaking up the nation's biggest banks into smaller units."
"[T]he big financial institutions will dig in to contest any breakups. Taking apart the big banks isn't costless. But it is the least costly alternative, and it trumps the status quo."
"Greater stability in the financial sector begins when TBTF ends and the assumption of government rescue is driven from the marketplace."
Former European Central Bank executive board member Otmar Issing in Financial Times, January 20, 2012, adds: "The problem of 'too big to fail' has made society-more precisely, the taxpayers-hostage to the survival of individual financial institutions.
"As a result, the basis of free markets has been shaken…Thus, 'too big to fail' not only undermines a fundamental principle of market economies but also a principle of societies in which individuals are responsible for their actions."
Let's hope these influential voices get the ball rolling quickly and effectively before taxpayers are again put on the hook to bail out another megabank.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.