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Home / Guest Commentary / Breaking up big banks isn’t really so simple

Breaking up big banks isn’t really so simple

By Paula Dwyer

Bloomberg View

Bernie Sanders has been advancing in the Democratic presidential polls. He and Hillary Clinton are in a statistical tie in Iowa. The Vermont senator has also widened his lead in New Hampshire.

The Sanders surge comes on the heels of a Jan. 5 speech in which he reiterated his crowd-pleasing pledge to break up the big banks. Supporters roared with approval when he said that “fraud is the business model of Wall Street” and that “Congress doesn’t regulate Wall Street — Wall Street regulates Congress.”

It’s easy to understand why they cheered. Banks have been in bad odor since irresponsible lending and high-risk practices helped crash the world economy in 2008. Breaking them up seems a simple way to cut them down to size.

But don’t be fooled. The legal, political and technical complications of breaking up banks, and the economic and financial risks of such an effort, make it dangerous and unworkable. Here are five reasons why:

1. Sanders’s analysis of what happened in the run-up to 2008 is wrong. To him, repealing parts of the 1933 Glass-Steagall Act in Bill Clinton’s administration invited the debacle. True, when commercial and investment banking were allowed under one roof, American banks got bigger and began peddling hedge funds, derivatives, insurance and real estate alongside plain old savings and checking accounts.

But blaming the law’s repeal misses the point. Most of the worst actors were smaller investment banks like Lehman Brothers and Bear Stearns, or commercial banks like Washington Mutual and Wachovia. Glass-Steagall wouldn’t have stopped them from overindulging in risky mortgages. And as the 1980s savings-and-loan crisis showed, small banks can wreak havoc, too.

2. The Federal Reserve and other regulators already have the authority to do what Sanders wants. Section 121 of the 2010 Dodd-Frank financial-reform law gives regulators enormous powers to seize and liquidate a firm that threatens the stability of the broader system.

If regulators believed a large bank posed a grave threat to the U.S. economy, they would have invoked those powers by now. The reason they haven’t is that Dodd-Frank provides less drastic tools to make banks safer.

Already under Dodd-Frank, the big banks have had to end trading done for their own profit and lay off armies of traders; sell hedge funds, commodities units and other forbidden subsidiaries; add hundreds of billions more in shareholder equity to absorb potential losses; process derivatives trades through central clearinghouses; and prepare road maps to their own liquidation if they become financially shaky. All this has made the big banks less risky.

3. In the unlikely event that regulators in a Sanders administration still don’t see the need to break up the banks, Congress would have to adopt legislation to require them to do so. That isn’t likely to happen, even if the Democrats have a majority in the House and Senate. Plenty of Democrats would join Republicans in voting against any such breakup law, given its unpredictable economic and financial consequences.

4. Suppose Congress did pass such a law. It’s unclear how regulators would split up, say, JPMorgan Chase, which got bigger after the crisis because the U.S. implored it to absorb Bear Stearns (ditto for Bank of America, which acquired Merrill Lynch and Countrywide). If regulators divided the bank into commercial and investment banking halves, how would they disentangle the interwoven asset and liability threads around the globe? Millions of contracts would have to be renegotiated. Lines of credit might have to be terminated because smaller banks can’t afford to finance them.

5. Using the brute force of government to divide big banks could so destabilize the financial system it might invite another crisis. Would the New York clearinghouse, which is operated by the largest banks to process trillions of dollars in daily payments, continue to work, for example? Would multinational corporations, which rely on global U.S. banks for payroll, short-term credit, bond issuance, currency exchange, hedging needs and many other services, have to switch to foreign banks if smaller U.S. banks can no longer afford to operate globally?

What’s lost in the heated rhetoric is that Sanders is fighting the last war. Clinton’s plan, while not perfect, recognizes this. She would extend Dodd-Frank to cover largely unregulated hedge funds and other shadow banks. She would impose a risk surcharge and tougher rules on trading operations.

As it stands, banks are finding the Dodd-Frank law has made it too costly to be big. It’s difficult to maintain the tougher capital levels the Fed requires and deliver the returns shareholders expect. Financial executives or activist investors eventually will do what Sanders wants, and break them apart — but by spinning off easily separated assets and with far less disruption than if done by government fiat.

Already, two large institutions that regulators have declared systemically risky — industrial conglomerate General Electric and insurer MetLife — are breaking themselves up.

So a President Sanders likely couldn’t accomplish what he’s promising. Worse, he could trigger another financial crisis if he did.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

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