Ending Too Big To Fail? Neel Kashkari at the Minneapolis Fed

(Tristan Loper CC BY-SA 4.0)

By Bill Barclay

Remember when bankers crashed the economy, destroyed your retirement savings, drove unemployment to over 9% – and then got a bail out from the rest of us? It was only seven years ago, but many seem to have forgotten. Neel Kashkari hasn’t. The former overseer of the Troubled Asset Relief Program (TARP), the program to take toxic debt off the books of the major banks, Kashkari is now calling for ending “too big to fail” (TBTF). Kashkari was appointed president and CEO of the Minneapolis Fed in late 2015.

There are 12 federal reserve banks (Feds); a board of governors meets in Washington. The New York Fed is generally considered the center of power, in large part because it is closely involved with U.S. financial markets. Each of the regional banks, however, can and do take on specific issues and analyses. Kashkari wasted no time in raising the issue of TBTF.

He is no radical. He came to Washington from Goldman Sachs as assistant to President George W. Bush’s Treasury Secretary Henry Paulson and later became assistant treasury secretary. Kashkari was deeply involved in the 2008 Financial Panic, including the negotiations that led to the takeover of Bear Sterns by JPMorgan Chase, and he helped design TARP. In 2014 he was the Republican candidate for governor of California, running against Jerry Brown.

While careful to say that Dodd-Frank (The Wall Street Reform and Consumer Protection Act) has accomplished some good, Kashkari argues for consideration of one or more of the following proposals, which are not mutually exclusive:

  • Breaking up the largest banks

  • Turning large banks into public utilities by forcing them to change their capital structure

  • Taxing leverage throughout the financial system

In pursuit of these goals, Kashkari has initiated a series of TBTF conferences at the Minneapolis Fed.

The first proposal is very similar to that pushed by both Sen. Bernie Sanders and Sen. Elizabeth Warren. The second bears passing resemblance to the idea urged by some on the Left to nationalize the largest banks with the goal of asserting democratic control over investment while maintaining their size. The third proposal goes to a core driver of financial sector growth, the use of leverage to increase – often dramatically – return on equity.

Breaking up banks was, in essence, what the Glass-Steagall Act did in 1933. Financial institutions were forced to choose one of three businesses lines: insurance, commercial banking or investment banking. In exchange for choosing commercial banking, the newly created Federal Deposit Insurance Corporation (FDIC) insured deposits, and commercial bankers had a 3/6/3 life: borrow at 3%, lend at 6%, hit the golf course at 3:00. As Sen. Warren has argued, the Glass-Steagall world was boringly devoid of systemic financial crises. And, when a single very large bank got in trouble – think Continental Bank in 1984, at that time the largest bank failure faced by the FDIC – the regulatory structure was sufficient to the task. Perhaps it was boredom that led to the effective gutting of Glass-Steagall in 1999 with the passage of Gram-Lech-Bliley (Financial Services Modernization Act)?

Of course we want democratic control of investment, but would breaking up the big banks still be a good course of action? It is not obvious that one precludes the other. And, of course, we are not, today, in a position of power where either outcome is likely in the immediate future.

To some extent the difference between breaking up the banks and nationalizing them is a difference in policy goals. Those who argue for breaking up TBTF banks are concerned about two things: the continued vulnerability of the financial system to crises and the huge political power wielded by the financial sector. (Kashkari is clearly more concerned about the former than the latter.) In contrast, the argument for nationalization is about how access to capital is determined.

Both arguments face difficulties. While, as socialists, we all want democratic control of investment, we have almost nothing in the way of a model of social control of financial institutions. Yes, there are the State Bank of North Dakota and Laboral Kutxa, the bank that finances the Mondragon cooperatives in Spain. These institutions, however, in no way resemble the TBTF banks that we have in the United States. The latter are many times the size of the former and carry out a much wider range of financial activities, particularly in the arena of financial market trading.

And perhaps size itself poses problems. Bureaucratic hierarchies, whether run in authoritarian or democratic manner, almost all suffer from problems of reliable information flow and resulting inefficient use of available resources. The big banks employ 150,000-250,000 people.

Lastly, it is not clear whether the nationalized TBTF banks would continue in their trading operations on the, presumably, not nationalized financial markets. If they did so, a major driver of financial sector size and risk would be unchanged.

Breaking up TBTF banks and/or limiting their size was proposed in the aftermath of the 2008 financial panic, but the proposal got limited political traction. As our memories have faded, the chances for this measure also wane. On the other hand, breaking up TBTF banks would be squarely in the U.S. anti-trust tradition: Standard Oil in 1911 and AT&T in 1984.

In addition to the beneficial impact of lessening the risk of financial crises, smaller banks with less economic power would also mean less political power for the sector, definitely a plus. It is also the case that large size is not essential to financing large public investments. Banks are not sitting there with huge amounts of cash in their (electronic) vaults that are then loaned out to entrepreneurs. Instead, the money-center banks raise the multiple billions required by marketing the debt issued by companies seeking to expand their operations. This debt issuance can be, and is, easily done by a syndicate of medium-sized institutions.

For me the most interesting proposal, and one that could easily be combined with others, is the idea of taxing leverage. During my almost quarter century working in finance, I frequently heard the “this time is different” argument: about S&Ls in the 1980s/90, the dotcoms in the late 1990s/early 2000s and, of course, the housing price bubble in the mid-2000s. Yes, the bubble asset was different, but the dynamic was always the same: leverage to drive high return on equity to make possible extending mortgage loans to those with no realistic chance of ever paying them off, etc. Taxing leverage, as hard as it might be to differentiate “good” and “bad” leverage, would mean a significant change in the financial sector and the larger U.S. political economy.

All this raises an underlying question: Why this proposal from an establishment banker and why now? I don’t have a good – or maybe any – answer to this question.

Bill Barclay is on the Steering Committee of Chicago DSA, is a founding member of the Chicago Political Economy Group and serves as DSA National Member Organizer.

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