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April 24, 2013

The Threat from Too Big to Fail Megabanks Must be Ended


“The last financial crisis will cost the U.S. more than $12.8 trillion, mostly from too-big-to-fail banks, firms and activities.  That threat, from only a handful of the biggest banks in the world, is now even bigger and still hangs over our country.  It must be ended.  Senators Brown and Vitter are proposing a new bill to change the behavior of the largest megabanks and protect the American taxpayer from having to bail them out again when they take large losses.  The key requirement of the bill is that the very largest megabanks finance at least 15 percent of all their assets with equity rather than borrowed money.  This is a modest requirement that should be immediately adopted,” said Dennis Kelleher, President of Better Markets, Inc., an independent nonprofit organization that promotes the public interest in the financial markets.

“Just like banks require borrowers to put 20 percent down to get a loan, megabanks should be required to have equity before they borrow trillions of dollars.  This requirement alone could dramatically improve the stability of the financial system.  It would make large banks better prepared to endure large losses and continue lending without having to be bailed out by taxpayers,” Mr. Kelleher said.

“This would make it much more difficult for them to amplify asset price increases and feed the formation of bubbles, as they did during the previous crisis.  It would make them less vulnerable to runs by the short-term lenders – including buyers of commercial paper and repo lenders – who deserted them en masse during the crisis.  And it would change the incentives of banks, since it would force the largest banks to bear more of the risks of their economic decisions.  These changes would help stabilize the financial system and reduce potential taxpayer exposure to loss,” Mr. Kelleher continued.

“The Federal Reserve’s current proposal to implement Basel III capital requirements is far weaker than Brown-Vitter with respect to borrowing and equity.  Under the Fed’s proposed rule, large bank holding companies are required to finance only 3 percent of their total assets with “Tier 1” capital – which includes liabilities other than equity,” Mr. Kelleher said.  “Three percent is nothing and will not protect U.S. taxpayers next time the megabanks get reckless.”

“The bill also addresses market distortions created by implicit federal support for all of the operations within large bank holding companies.  It proposes to end Federal Reserve lending to non-depository subsidiaries, through the discount window or emergency lending facilities.  The bill also prohibits the transfer of the liabilities of nonbank subsidiaries onto the balance sheets of insured depositories.  These two changes would make it clear to capital market lenders that the non-depository subsidiaries of large bank holding companies will not be rescued if they get into trouble.  This will increase market discipline of very large bank holding companies,” said Mr. Kelleher.

“This bill takes a thoughtful and consistent approach to the problems that large bank holding companies create for the financial system.  It adopts regulatory strategies that are opened up by the Dodd-Frank Act, but which banking regulators have so far refused to pursue.  Critics of the bill have their work cut out for them,” Mr. Kelleher concluded.

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