As a retired banker and one who struggled mightily through the Texas banking debacle of the mid-1980s, the current debate over the “too big to fail” problem resonates with me. I served as CEO of a sizable banking organization, but one that was not considered too big to fail, and I watched other banks that were so anointed receive preferential treatment from regulators who were woefully deficient in competency to deal with the massive asset valuation collapse of the time.
Tom Frost, of the venerable San Antonio banking franchise that bears his family name, has recently written a perceptive essay in the Wall Street Journal in which he decries the “too big to fail” moral hazard that plagues the banking regulatory environment, and suggests that the solution to the dilemma is to separate the two business cultures in commercial banking–the basic business of intimate depository and credit relationships with local and regional customers and the higher risk business of proprietary trading in global financial markets which threaten the first culture if they are allowed to exist within the same institution.
There was a time, 25 years ago, when I was supportive of the integration of these two cultures in the belief that the market was a corrective to abuses, but my experience in the 1980s and the continuing concentration of commercial banking assets in institutions that are so dominant as to represent a compelling moral hazard have changed my view. An institution too big to fail is too big, and we compound the problem by attempting to identify those institutions, bank and non-bank, that embody “systemic” risk, as the Federal Reserve is attempting to do, thereby signaling that these will have priority with government assistance in the event of impending failure. This won’t do. It actually increases the problem of moral hazard and is a further perversion of the regulatory overkill already embodied in the Dodd-Frank law.
As Allan Metzler of Carnegie Mellon University has noted, we need more capital in banks, not more rules, which are an inadequate substitute. Bankers can’t add value without taking on risk, but commercial banks need to be able to respond to their customers without the burden of regulatory micromanagement, and with clear capital requirements that penalize them for excessive risk.
In addition, we need deposit insurance reform. Thirty years ago, FDIC insurance was $40,000 per account, and it was increased to $100,000 on a stealth basis in 1982. Now it is $250,000. The insurance of depository accounts was never intended to cover more than the funds of a modest household. Bank deposit reform has been elusive, but we should take it on, and it should require that institutions pay a risk-adjusted premium for insurance of accounts, in addition to introducing a sliding scale of coverage for depositors beyond a modest minimum coverage per account.
The bottom line is that Dodd-Frank should be recognized as a gross regulatory overreaction to a crisis and repealed. Then we can start over with the proper recognition of the characteristics of the two banking cultures, as well as revised capital requirements and deposit insurance reform that provide the proper incentives and consequences for risk management.