The Future of America's Banks

In 1998 the largest American bank was only the 25th largest bank in the world. In 1999, the Glass-Steagel Act was abolished which effectively reduced the legal constraints that had been implemented against large banks during the Great Depression. Since GS was abolished, commercial and investment banks have been allowed to merge together into super-banks. Bear Stearns, Goldman Sachs, Morgan Stanley, and Washington Mutual are good examples of this class of super-banks. These super-banks have been (probably rightfully so) for the current financial crisis. When these banks failed, they were classified as "Too Big To Fail" (TBTF) and were not allowed to file for bankruptcy. In reality, their size was not as important as how interconnected they were to other institutions. If one institution failed, the whole house could come barreling down. Lehman Brothers is the classic example of why a TBTF insititution should not be allowed to fail.

The TBTF policy has been criticized since the recession began. Therefore, policymakers have begun making policy change recommendations. These have included going back to the Glass-Steagel days, breaking up all banks that are 'large', or doing nothing at all. The last several weeks have revealed which direction policymakers are probably heading. First, there will probably be constraints against large banks. Regulators could charge very high insurance fees for the largest banks that could make it so no bank could become large. Or, banks that exceed a certain size may undergo excessive amounts of regulation and monitoring. These calls against large banks have been made primarily in Congress and are gaining popularity. There is a chance that America will not have a large bank for an entire generation.

There is another train of thought that is a little more market friendly. Thomas Hoenig of the KC Federal Reserve recommends that a regulator be given the authority to step in and takeover large failing financial institutions. The instiution's management would be fired and the stakeholders wiped out, but the rest of the institution would be held in tact. This would give the management team the incentive to take limited risk, but also the incentive to maximize profit and revenue. The only constraint would be the insurance the large firms would have to pay for siezures, and this would probably welcomed by the financial system because each firm would have more confidence in the other firms they are interacting with! Hoenigs plan most closely resembles Barney Frank's proposed bill.