- The Washington Times - Monday, November 9, 2009

An unusual alliance of conservatives and liberals is pushing to break up or downsize banks deemed “too big to fail,” rather than create a new regulatory regime led by the Federal Reserve to try to keep them from getting into trouble again.

Public anger toward bailouts and the central bank’s role in rescuing big institutions like American International Group Inc. and Bank of America Corp. are fueling growing opposition to the Fed-led oversight plan advocated by the Treasury Department and House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat.

In Europe, regulators are moving to break up megabanks like ING Group, KBC and Lloyds that became government wards after last year’s global financial meltdown. An increasing number of legislators, political activists and financial specialists in the U.S. want to move in the same direction for troubled institutions such as Citigroup and Bank of America.

Critics contend that these banks have learned little from the crisis and are milking the substantial funding advantage they have gained as a result of their government backing to go into risky ventures that pumped up their profits this year, but might be setting the stage for speculative bubbles and financial crises down the road. The Fed, they say, failed to see these problems before and would probably miss them again.

“The real culprits in this crisis were the large and mostly regulated banks in the United States and Europe. The size and extreme risk-taking by these institutions were among the key factors behind the depth of the crisis,” said Nariman Behravesh, chief economist at IHS Global Insight.

“Unfortunately, the problem has become worse. Consolidation through distressed mergers and acquisitions in the wake of the events a year ago has made the concentration in the banking industry even greater,” he said, “setting the stage for future banking crises if appropriate steps are not taken to either break up the large banks or to regulate them even more tightly.”

Peter Schiff, president of Euro Pacific Capital and a Republican economic adviser, questioned whether it is desirable to allow banks to become too big to fail in the first place and then try to rein them in through regulation.

“If the government did not provide these bailouts or guarantees, then the market itself would ensure such organizations did not grow beyond their ability to attract capital,” he said. “It is only when fear is overcome by government guarantees that systemic risks can arise.”

While the Fed has sought recently to burnish its regulatory credentials by showing that it can be tough on big banks, proposing for the first time to regulate executive pay at the 28 largest firms, many legislators and analysts point out the Fed already had authority to regulate Citigroup Inc., Bank of America and other giant banks, but failed to foresee problems or take pre-emptive action while the crisis was developing.

Critics say the Fed may be too conflicted to crack down on big banks, since the Fed’s 12 reserve bank presidents are elected by top bank executives who typically sit on the reserve banks’ boards of directors. Before he went to Treasury, Secretary Timothy F. Geithner himself was selected by top New York banks like Citigroup and JPMorgan Chase & Co. to fill the critical post of New York bank president, the Fed official who interacts most closely with the big banks and Wall Street markets and who arranges most of the bailouts.

“Anointing the Fed as the systemic-risk regulator will make what has proven to be a bad bank regulator even worse,” said Sen. Richard C. Shelby, ranking Republican on the Senate banking committee. “It was the Fed that failed to adequately supervise Citigroup and Bank of America, setting the stage for bailouts in excess of $400 billion. It was the Fed that failed to adopt mortgage underwriting guidelines until well after this crisis was under way. It was the Fed that said there was no need to regulate derivatives.”

Opposition to giving the Fed even greater power has led Financial Services Committee Republicans to endorse enhanced bankruptcy or government resolution procedures to handle large failing banks, along with other incentives that prompt the banks to essentially downsize themselves. Tough measures such as prohibitively high capital and deposit-insurance premiums that reflect the greater risks they take would force the banks to consider whether it’s worth growing so large in the first place.

While conservatives and liberals have little else to agree on these days, on the “too big to fail” question, Republicans increasingly find themselves reading from the same page as Ralph Nader, the AFL-CIO and an array of other progressive organizations that have also concluded that the best way to prevent future bailouts is to downsize the huge banks that now dominate everything from credit cards to mortgages and emerging market investments.

“It is hard to look at what was done over the past year and a half and conclude it was anything less than disastrous,” said Robert Weissman, president of Mr. Nader’s Public Citizen group. “The bailout strategy is unacceptable. It unjustifiably plunders the public treasury to support failed, reckless enterprises while reinforcing the cycles that lead to periodic failure and ever-larger bailouts.”

The Nader group is recommending breaking up firms that are too big to fail and reinstating Depression-era rules that prohibit commercial banks from engaging in speculative investment activities, as well as empowering the government to close down such firms in an orderly way if they fail in the future.

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