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Breaking Banks:  Why Haven't We Done This Yet?

Breaking Banks: Why Haven't We Done This Yet?

Approximately 1.2 million families lost their homes due to the crash of the housing market between 2005 and 2008 and millions of people lost their jobs. The reckless behavior of large banks and government (de)regulators over the course of a decade nurtured a housing bubble, nearly causing the crash of America’s largest financial institutions in 2008. The Bush Administration responded to the crisis by establishing the Troubled Asset Relief Program (TARP), setting aside $700 billion to bail out the banks. $417 dollars from the program were dispersed over the following four years to save struggling financial institutions. The consensus was that the banks were simply too interconnected into the entire economy to allow them to collapse. Despite promises by government officials to reduce the size of banks to prevent a similar scenario from playing out in the future, most notably with the Dodd-Frank Act, the country’s four largest commercial banks have only grown in size since the crisis began. In 2006, J.P. Morgan, Bank of America, Citi Group, and Wells Fargo held over $5 trillion in total assets or 44 percent of the national total; by 2015, the number had risen to 51 percent or over $8 trillion in assets. Why are these institutions so difficult to break up? Furthermore, what can be done to reduce the risks in our financial system in the future?

Part of the reason for the consolidation of this sector of the economy over the last few decades is that commercial banks have had many technological incentives to merge with one another. The rise of digital technology in the form of credit cards, ATMs, and online banking made it so that smaller banks that lacked the sufficient capital to invest in these new financial tools found it preferable to merge with larger companies. In addition, globalization made it so that commercial and investment banks could expand their geographic reach into new markets domestically and internationally. This required larger and more diverse staffs of well-trained researchers, so many banks merged together to increase the pool of talent among their employees. Finally, more mobile customers have demanded greater access to their banks in different parts of the country and the rest of the globe, which created greater incentive for concentration of the financial sector. This is partly why the number of banks decreased from 14,407 in 1980 to 8,697 in 1998. In that same time period, the share of the largest one hundred rose from 47 to 71 percent of the total market share. These tech-driven dynamics are still acting on the industry today.

Prior to the 1980’s, most of these mergers and take-overs would have been impossible due to government regulations. Laws like the 1914 Clayton Anti-Trust Act were used to break apart companies whose size threatened the stability of the economy. The Glass Steagall Act of 1933 prevented commercial banks from merging with other financial institutions such as investment banks and insurance companies, and the McFadden Act of 1927 limited interstate banking. However, with the rise of neoliberalism in the 1980’s came a series of new laws that removed most of these restrictions on the horizontal and vertical growth of financial institutions. One of the most notable was the repeal of Glass Steagall in 1999 through the Gramm-Leach-Bliley act, which allowed investment banks to gamble with the money deposited by customers in commercial banks. Deregulation of the financial sector was justified on the grounds that digital technology and globalization created the need to restructure the industry.

Although these reforms increased the efficiency of banking services and provided American citizens with easier access to capital, the growing size of these institutions created new problems. For one, large banks were able to enhance their influence on the political system due to their size and looser campaign financing restrictions. By 2014, commercial banks spent $24.2 million on the electoral campaigns of politicians at the federal level, and $63 million was spent on lobbying. From 2015 to 2016, Hillary Clinton alone received over one million dollars from financial institutions for her presidential campaign, and Jeb Bush led the field among Republicans with over half a million dollars in contributions received. Additionally, in 2014, 267 bank lobbyists out of a total of 422 formerly worked for the government. This type of political influence has allowed the banks to push for lax regulations and lower taxes.

The growing size of the banks also encouraged more risky behavior since the largest institutions were well aware that they had grown too big to fail. Like the oil industry, banks are interconnected into every aspects of the economy. The largest commercial banks have extensive investments in the country’s top mutual funds like Vanguard and Blackrock Institutional Trust, who in turn have large stakes in the top 500 companies on the New York Stock Exchange. Furthermore, an analysis of the ownership structure of America’s largest financial institutions reveals that their owners consist of the country’s largest mutual funds as well as pension plans of public workers from dozens of states, including California, New York, Florida, and Ohio. Since over half of America’s financial assets are located in only four banks, the crash of only one of them would have devastating consequences for the rest of the economy.  These banks are well-aware of their privileged and protected status and are thus more willing to engage in risky speculation.

Following the housing market collapse and the subsequent financial crisis, politicians and a growing segment of the public became aware of the danger posed by having too much concentration of wealth in the banking sector, which led to the passing of the Dodd-Frank Act. The new law created a new oversight committee that would monitor the banks for the type of risky behavior that led to the housing market crash and protect consumers from fraud. The Volker Rule within the act also places new limits on the ability of commercial banks to invest depositor money in the stock market and mutual funds, and new limits were placed on the trade of derivatives.  Part of the legislation also stipulated that a single bank could not control more than ten percent of the country’s assets. More importantly, a clause in the law allows for the executive branch, with the approval of the Federal Reserve, to break apart a large bank if they deem its size to be a danger to the economy. Many of the reforms within Dodd Frank have been enforced, and this has arguably brought greater stability to the financial system. It is harder now for banks to issue unsafe, predatory loans to prospective home owners.

However, why did Dodd-Frank fail to decentralize the banking sector? The reasons are complicated. Section 121 of the law only allows the president to break apart a bank only if two thirds of the board members of the Financial Stability Oversight Council as well as the seven members of the board of governors of the Federal Reserve agree that the bank is at risk. The details are in the fine print. Since new members of the Federal Reserve are appointed by the president and vetted by the Senate for fourteen year terms, it will take several years before these board members can be replaced. Furthermore, appointing new officials that are in favor of reform will require the cooperation of Republicans and Democrats in the Senate, which is not likely to happen anytime soon due to the problems with campaign financing. In other words, it will require an act of congress to help break up the banks. Ironically, the enforcement of other parts of the Dodd Frank Act made it more costly for smaller banks to operate, which encouraged even more mergers and take overs following the passage of the bill.

It should be noted that simply breaking up the banks is not a magic bullet for solving all of the problems in the financial sector. Greater oversight and accountability is needed. Furthermore, taxes need to be raised on capital gains, and banks need to hold higher leverage in relation to the amount of money they loan to customers. This would reduce risky behavior. After all, small and medium sized banks can also have problems with speculative activity that is too risky. However, we should not underestimate the importance of reducing the size of these institutions as the failure of one of the big four could have grave consequences for the entire economy and the country’s political stability in the future.  Given the continued advances in banking technology along with the problem of unregulated campaign financing, breaking the banks in the future will be an uphill struggle.  

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