First. here's
Mark Thoma claiming that the current bill doesn't end too big to fail:
This bill is not going to end the problem of too big to fail. If the banking system is threatened, then one way or the other it will be bailed out. The consequences to the economy would be too large to do otherwise. Thus, banks that are big enough to pose a systemic risk enjoy an advantage over other banks. Banks that pose a systemic risk will be assumed to be safer than other banks due to the implicit government guarantee. This gives large banks an advantage over smaller banks that do not, on their own, threaten the financial system if they fail.
But what exactly is he talking about? When has there ever been a law that allows the break up big banks that pose a systemic risk?
The claim made by some that reinstating Glass-Steagall would do this ignores that Glass-Steagall wasn't about the systemic risk posed by the size of commericial banks. Glass-Steagall was about separating commercial banking from investment banking:
•Banking Act of 1933 (P.L. 73-66, 48 STAT. 162).
Also known as the Glass-Steagall Act. Established the FDIC as a temporary agency. Separated commercial banking from investment banking, establishing them as separate lines of commerce.
linkHere is
Robert Knutter describing Glass-Steagall in 2007:
Rubin's crowning achievement was the repeal of the 1933 Glass-Steagall Act, which had separated largely unregulated and more speculative investment banks like Goldman Sachs from government-supervised and -insured commercial banks like Citi, which play a key role in the nation's monetary policy. Glass-Steagall was designed to prevent the kinds of speculative conflicts of interests that pervaded Wall Street in the 1920s and helped bring about the Great Depression (and reappeared in the 1990s).
Glass-Steagall was steadily weakened by regulatory exceptions under three administrations going back to George Bush Senior. The premise was that tearing down the regulatory walls would promote competition. But the effect was to create greater concentration and renewed opportunities for insider enrichment.
Krugman:
Too big to fail FAILI’m a big advocate of much strengthened financial regulation. One argument I don’t buy, however, is that we should try to shrink financial institutions down to the point where nobody is too big to fail. Basically, it’s just not possible.
The point is that finance is deeply interconnected, so that even a moderately large player can take down the system if it implodes. Remember, it was Lehman — not Citi or B of A — that brought the world to the brink.
And as far as I know, there never was a time when policymakers could have viewed the collapse of a major money center bank with equanimity.
They certainly were worried about systemic risk in 1982, when I had something of a front-row seat. There were fears that the Latin debt crisis would take down one or more money center banks — Citi, or Chase, say. And policy was shaped in part by the desire to make sure that didn’t happen. Bear in mind that this was in the days before the repeal of Glass-Steagal, before finance got so big and wild; the New Deal regulations were mostly still in place. Yet even then major banks were too big to fail.
So I think of the pursuit of a world in which everyone is small enough to fail as the pursuit of a golden age that never was. Regulate and supervise, then rescue if necessary; there’s no way to make this automatic.
So when Thoma says "Banks that pose a systemic risk will be assumed to be safer than other banks due to the implicit government guarantee." He's really talking about a risk that existed even before the repeal of Glass-Steagall.
Here is
Robert Knutter earlier this month:
Bring Back Glass-Steagall: Among the crucially important provisions that did not make it into either final bill is the Merkley-Levin amendment which would draw a bright line separating taxpayer-insured commercial banks from financial firms that gamble and trade derivatives and other risky other securities for their own accounts (the "Volcker Rule.") There is still a decent chance that this could make it into the final bill.
It did make it into the bill. The current bill does exactly what Glass Steagall did---separate commercial banking from investment banking---and more through a combination of the Volcker Rule and Lincoln's derivatives provision.
Here is
Joseph Stiglitz:
Some argue that a sufficiently strengthened Volcker rule — including the Levin-Merkeley amendment — will suffice. But even ignoring the carveouts (e.g., for market making and customer facilitation), Section 716 and a strong Volcker rule should be viewed as complementary, not as substitutes.
The real concern should be that even with both in place, a too-big-to-fail institution not FDIC-insured could still pose systemic risk.
Derivative regulation is becoming the litmus test of regulatory reform. If the provisions stay, it will be a sign that broader interests and democratic forces will prevail over special and money interests.
More
Stiglitz:
I strongly support the passage of the derivatives and swaps regulation sections of the Senate Financial Reform Bill and especially Section 716 (“Prohibition Against Federal Bailouts of Swaps Entities“). If the Senate fails to pass strict regulatory oversight over dangerous over-the-counter derivatives and swaps, then the U.S. economy will continue to be vulnerable to significant financial risks.
Many economists agree that the unregulated, over-the-counter derivatives market played a key role in transforming a financial downturn into a global economic calamity. The derivatives regulation amend-ments that Senators Lincoln and Dodd have incorporated into the “Restoring Financial Stability Act of 2010” bring a critically important measure of regulation over dangerous derivatives and swaps prod-ucts by requiring: exchange-trading and clearing of most standard derivatives; the prudential regulation of major swaps dealers, including capital reserves requirements and business conduct rules; the spin-ning off of risky swaps desks from the systemically risky banks; and the ability of regulators to ban swaps that lead to financial instability or have no economic purpose.
In addition, look at the
new powers given to the FDIC that were not covered by Glass-Steagall:
- Funeral Plans: Requires large, complex financial companies to periodically submit plans for their rapid and orderly shutdown should the company go under. Companies will be hit with higher capital requirements and restrictions on growth and activity, as well as divestment, if they fail to submit acceptable plans. Plans will help regulators understand the structure of the companies they oversee and serve as a roadmap for shutting them down if the company fails. Significant costs for failing to produce a credible plan create incentives for firms to rationalize structures or operations that cannot be unwound easily.
- Liquidation: Creates an orderly liquidation mechanism for FDIC to unwind failing systemically significant financial companies. Shareholders and unsecured creditors bear losses and management and culpable directors will be removed.
- Liquidation Procedure: Requires that Treasury, FDIC and the Federal Reserve all agree to put a company into the orderly liquidation process because its failure or resolution in bankruptcy would have adverse effects on financial stability, with an up front judicial review.
- Costs to Financial Firms, Not Taxpayers: Taxpayers will bear no cost for liquidating large, interconnected financial companies. FDIC can borrow only the amount of funds to liquidate a company that it expects to be repaid from the assets of the company being liquidated. The government will be first in line for repayment. Funds not repaid from the sale of the company’s assets will be repaid first through the claw back of any payments to creditors that exceeded liquidation value and then assessments on large financial companies, with the riskiest paying more based on considerations included in a risk matrix
- Federal Reserve Emergency Lending: Significantly alters the Federal Reserve’s 13(3) emergency lending authority to prohibit bailing out an individual company. Secretary of the Treasury must approve any lending program, and such programs must be broad based and not aid a failing financial company. Collateral must be sufficient to protect taxpayers from losses.
- Bankruptcy: Most large financial companies that fail are expected to be resolved through the bankruptcy process.
- Limits on Debt Guarantees: To prevent bank runs, the FDIC can guarantee debt of solvent insured banks, but only after meeting serious requirements: 2/3 majority of the Board and the FDIC board must determine there is a threat to financial stability; the Treasury Secretary approves terms and conditions and sets a cap on overall guarantee amounts; the President activates an expedited process for Congressional approval.
Something the bill does for the first time ever,
regulate hedge funds:
Raising Standards and Regulating Hedge Funds- Fills Regulatory Gaps: Ends the “shadow” financial system by requiring hedge funds and private equity advisors to register with the SEC as investment advisers and provide information about their trades and portfolios necessary to assess systemic risk. This data will be shared with the systemic risk regulator and the SEC will report to Congress annually on how it uses this data to protect investors and market integrity.
- Greater State Supervision: Raises the assets threshold for federal regulation of investment advisers from $30 million to $100 million, a move expected to significantly increase the number of advisors under state supervision. States have proven to be strong regulators in this area and subjecting more entities to state supervision will allow the SEC to focus its resources on newly registered hedge funds.
So the current bill separates commercial from investment banking and in addition, regulates hedge funds for the first time and empowers the FDIC to deal with large complex institutions that pose a systemic risks, which Glass-Steagall did not address.