The battle over "too big to fail" is heating up in Washington
An FKD Feature exclusive

Eight years after the financial crisis that triggered the Great Recession, prominent policy makers are still floating the idea of breaking up banks. Since we’re still living with the economic fallout from that financial crisis, there are loud voices clamoring for policies that ensure that the 2008 banking crisis never happens again.

Prominent face, aggressive agenda

One of the most prominent figures in the movement to overhaul our banking system is Minneapolis Federal Reserve Chief Neel Kashkari. This week Kashkari held a conference to help address the “too big to fail” problem.

Essentially, banks have become so large that the government cannot allow them to collapse, so they’re pretty much guaranteed to get a federal bailout should they run into problems. Of course, this creates a dangerous moral hazard for the large banks, which are effectively incentivized to make risky bets.

The dangers of messing up

A properly functioning banking system is the foundation of a modern economy. That’s why regulating the banks is so touchy: overregulation or underregulation of American banks has the potential to make or break our economic prospects. If regulators are overzealous, they risk strangling economic growth. If they are too light on banks, then we’re risking another devastating financial crisis.

Is Dodd-Frank fixing or failing?  

If you’ve been following trends in banking regulation in recent years, you’re probably familiar with the Dodd-Frank Bill, which sought to prevent another financial crisis. Unfortunately, there have been many unintended side effects with this legislation. A recent study by the Harvard Kennedy School found the market long-declining market share of community banks rapidly accelerated in 2010, the year of the bill’s passage.

One culprit in this scenario may be the increased cost of regulatory compliance faced by banks, which encourages mergers and consolidations with other banks so as to split the cost burden. While we would like to believe we have learned our lessons from the previous crash, the U.S. banking landscape today is once again dominated by a few mammoth banks that are likely too big to fail.

Kashkari’s plan and opponents

Kashkari, a former banker himself, has outlined a plan he hopes will benefit smaller banks, while breaking up the concentration of capital and influence dangerous to the economy. “If we can truly address the risks posed by large banks, perhaps we can relax the burdens small banks are facing,” he told The Wall Street Journal.

Kashkari wants banks to have a bigger cushion by law, otherwise known as increasing their capital requirements. According to CNBC, this would force the largest U.S. banks to hold so much capital that they would likely break themselves up.

In essence, this plan breaks up the giants, while clearing the field for the smaller banks. Notably, none of the big banks attended Kashkari’s conference on breaking up the banks.

Opponents say that forcibly breaking up the banks will make the U.S. banking system less competitive. There’s also an argument floating around that blames over-regulation like Dodd-Frank for our slow economic growth. More regulation, they say, would doom us to an even slower economy, perhaps even knocking us into a recession.

The unlikely figurehead 

In some ways, Kashkari is the unlikely figurehead of the movement to break up the banks. While his position at the Fed has no control over banking regulation, he personally witnessed the financial crisis firsthand as the right hand man of Treasury Secretary Hank Paulson. He later ran the $700 billion Troubled Asset Relief Program meant to help stabilize the financial system. After losing his bid for governor of California in 2014, he was named the Federal Reserve Chief in Minneapolis.

Takeaway

Banking regulatory decisions profoundly affect us all. The problem with Dodd Frank is that it may be entrenching the very problem it was meant to solve, thus leaving us at risk for another financial meltdown. If things crash and burn, expect a lot of finger pointing.

While Kashkari’s plan holds some promise, President-elect Donald Trump has yet to articulate policy specifics on the banking regulation front. At this point, anything can happen.

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Header image: Shutterstock

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Posted 11.16.2016 - 01:11 pm EDT