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May 9, 2012

Ending the Too Big To Fail Threat to the Country

The Senate Banking Committee’s Subcommittee on Financial Institutions and Consumer Protection is holding a hearing today to examine policy ideas to reduce the threat to the country from the gigantic too-big-to-fail banks.  Those are the 10 or so biggest banks that are so large that their failure would cause the financial system and our economy to collapse if they failed.  That’s why they are too big to fail:  no government would let them fail because of the consequences to the country.  That’s what happened in 2008 and that’s why taxpayers, the Fed, the FDIC and the Treasury were forced to bail out the banks.  The hearing will focus on figuring out how to prevent these few banks from taking down the rest of the banking system and the economy.

Marc Jarsulic, chief economist of Better Markets, will testify at the hearing today.  Mr. Jarsulic will stress that regulators already have the tools available to ensure taxpayers won’t be forced again to bail out the banking industry.  Those tools are in the financial reform law called the Dodd Frank Act.  We don’t have to reinvent the wheel.  Using the authority given them in Dodd Frank, regulators just have to put in place tough rules that will impose strict leverage and trading requirements on these large banks.  You can read Marc’s full submitted written testimony below.

To ensure too-big-to-fail becomes a memory and not a recurring nightmare, regulators must do the following:

•         Impose strong leverage requirements on big banks that increase with their asset size. Proposed international Basel III standards are not likely to constrain bank leverage for big banks. The Federal Reserve should reconsider its decision to rely on the Basel standards, and take into account recent research by the Centre for Economic Policy Research indicating that a maximum leverage ratio for risk-weighted assets should be five to one.

For more on information on the capital standards, read here.

•         Require a strong Volcker Rule that will take away incentives to place risky bets that can put financial markets at risk when they turn bad. Regulators should limit “market making” compensation to spreads, fees and commissions; impose tough sanctions for violations; and narrowly limit the hedging exemption so it does not disguise speculative trading.

For everything you need to know on the Volcker Rule, click here.

•         Regulate the estimated multitrillion-dollar shadow banking system to provide accountability and oversight. The Financial Stability Oversight Council has adopted rules to cover significant nonbank firms and products. Regulators should especially focus on the repo and asset-backed commercial paper markets, which both experienced runs during the financial crisis, to prevent a repeat that would put the U.S. economy and taxpayers at risk.

Read our comment letter to regulators on how to regulate the shadow banking system.

For a broader discussion of these issues, read What Financial Reform is all About and Why Wall Street Hates It here and The Other 99% vs. 1%: All Banks vs. Wall Street’s Biggest Banks here.



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