The Failure To End “Too Big To Fail”

The facts, as Wall Street insider-turned-investigative journalist Nomi Prins laid them out Thursday in her talk at the Economic Policy Institute, are a damning indictment of the performance of our politicians. One year after a frenzy of financial industry bailout actions that has put American taxpayers potentially on the hook for more than $17 trillion, our national economy is even more dominated by lumbering, so-called “too big to fail” institutions who are fighting tooth-and-nail to keep risking our global economic security at the Wall Street gambling casino.

It’s not just the Nomi Prins’ of the world who are alarmed. On the same day that Prins was talking about her new book on the Wall street financial crash and its aftermath, “It Takes A Pillage,” former Federal Reserve Bank chairman Paul Volcker, now the chairman of the white House Economic Recovery Advisory Board, was raising similar alarms in testimony before the House Banking and Financial Services Committee. His concern is the moral hazard created when large institutions believe that regardless of how they behave in the marketplace, the federal government will be there to prop them up and clean up their messes.

However well justified in terms of dealing with the extreme threats to the financial system in the midst of crisis, the emergency actions of the Federal Reserve, the Treasury, and ultimately the Congress to protect the viability of particular institutions – their bond holders and to some extent even their stockholders – have inevitably left an indelible mark on attitudes and behavior patterns of market participants.

As a result, as Prins said, even though Wall Street as well as Main Street was burned badly by the trading of derivatives, credit default swaps and other exotic financial instruments—including bundles of what turned out to be fraudulently issued mortgages—we now have “more risk this year, more profits, more bonuses, more consumer losses. There is no change there, except to worsen.”

“Too Big To Fail Shouldn’t Be”

Nomi Prins, senior fellow at Demos, speaks Thursday at the Economic Policy Institute.

The thrust of the solutions now being considered by the Obama administration and Democratic leaders in Congress are largely confined to managing the financial system, when the real solutions lie closer to a full-scale restructuring.

The banking institutions that got themselves into trouble by gambling with investor dollars in exotic, high-risk financial instruments—pursuing the reward of six- , seven- and even eight-figure bonuses—are now making new gambles with taxpayer dollars, Prins said. “That needs to change, and the way to change that is to make the banks smaller. If banks are too big to fail— they shouldn’t be.”

If there are financial institutions that want to keep playing high-stakes poker on Wall Street, they should be willing to accept a bit of Capitalism 101: If you lose, you lose. You don’t get to give a ransom note to the rest of society that says if you don’t get a government bailout, you’ll bring down the whole economy.

That’s the way it used to be before conservatives, in the name of freeing up financial markets, in the 1980s effectively dismantled the Glass-Steagall Act, which walled off consumer banking from other investment businesses. The ironic result is today’s socialized risk, compounded by the fact that what has emerged from last year’s Wall Street wreckage are even larger financial behemoths—Bank of America, Chase and Walls Fargo—that are spending millions of dollars fighting financial regulations that would constrain their behavior.

Volcker disagrees with the left on some policy solutions, but he does support rebuilding some of the walls so that only the bettors, not the taxpayers, pay for bad bets in the marketplace:

As a general matter, I would exclude from commercial banking institutions, which are potential beneficiaries of official (i.e., taxpayer) financial support, certain risky activities entirely suitable for our capital markets.

Ownership or sponsorship of hedge funds and private equity funds should be among those prohibited activities. So should in my view a heavy volume of proprietary trading with its inherent risks. Some trading, it is reasonably argued, is necessary as part of a full service customer relationship. The distinction between “proprietary” and “customer-related” may be cloudy at the border. But surely by the active use of capital requirements and the exercise of supervisory authority, appropriate restraint can be maintained.

But since such allies of the status quo as the U.S. Chamber of Commerce are spending millions of dollars to fight something that should be a given—a consumer financial regulatory agency that would protect ordinary people from unscrupulous and opaque financial deals—it has proven difficult to get a more forceful and progressive agenda on the table.

Groups such as Americans for Financial Reform and Jobs for Justice are nonetheless pushing that envelope, using demonstrations and other tactics starting this week to push the “break up the banks” message. At EPI on Thursday, Heather Booth, the executive director of Americans for financial Reform, was optimistic. “It’s a David and Goliath battle,” she said. “But we know how that turned out.”


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