The Obama Administration's Financial Regulatory Reform: A New Foundation does what ever it can to preserve "Too Big to Fail" institutions. The proposal calls "Too Big to Fail" financial conglomerates Tier 1 Financial Holding Company. This is from the White Paper: Financial Regulatory Reform:
Any financial firm whose combination of size, leverage, and interconnectedness could pose a threat to financial stability if it failed (Tier 1 FHC) should be subject to robust consolidated supervision and regulation, regardless of whether the firm owns an insured depository institution.
Translation: We are OK with financial institutions - Tier 1 FHC - that can cripple the entire global financial system such as Citigroup because we are going watch them more closely.
Reality: Financial conglomerates pay people lots of money to stay five steps ahead of any regulator. Labeling a financial conglomerates a Tier 1 FHC and supervising them more robustly is not going to stop a Tier 1 FHC to repeat what they did in the past decade.
Reason No. 1: The Fed has sole discretion to designate a financial conglomerate a Tier 1 FHC.
SEC. 6. SUPERVISION AND REGULATION OF TIER 1 FINANCIAL HOLDING COMPANIES.
(a) AUTHORITY TO DESIGNATE TIER 1 FINANCIAL HOLDING COMPANIES.—
“(A) UNITED STATES FINANCIAL COMPANIES.— The Board, on a non-delegable basis, may designate, by regulation or order, any United States financial company as a United States Tier 1 financial holding company, if it determines that material financial distress at the company could pose a threat to global or United States financial stability or the global or United States economy during times of economic stress based on a consideration of the following criteria:
(i) the amount and nature of the company’s financial assets;
(ii) the amount and types of the company’s liabilities, including the degree of reliance on short-term funding;
(iii) the extent of the company’s off-balance sheet exposures;
(iv) the extent of the company’s transactions and relationships
with other major financial companies;
(v) the company’s importance as a source of credit for households, businesses and State and local governments and as a source of liquidity for the financial system;
(vi) the recommendation, if any, of the Financial Services Oversight Council; and
(vii) any other factors that the Board deems appropriate.
That is a lot of authority to have especially for an institution that has a horrible history of regulating bank holding companies and other aspects of the financial system. There is authority to designate a Foreign Tier 1 FHC. Oh, and if a financial conglomerate has a right to a hearing to challenge the Fed's determination.
Reason No. 2: Explicitly and implicitly creates a tiered and "most favorite" financial system.
The use of the term "Tier 1 FHC" says a lot. What about Tier 2 and Tier 3? But this proposal is actually stating what is happening now - smaller regional and community banks are allowed to fail but TBTF get trillions in taxpayer money to survive. This all about preserving the financial oligarchy.
Paul Volcker said it in a more diplomatic way:
The approach proposed by the Treasury is to designate in advance financial institutions “whose size, leverage, and interconnection could pose a threat to financial stability if it failed”. Those institutions, bank or non-bank, connected to a commercial firm or not, would be subject to particularly strict and conservative prudential supervision and regulation. The Federal Reserve would be designated as consolidated supervisor. The precise criteria for designation as “systemically important” have not, so far as I know, been set out. However, the clear implication of such designation whether officially acknowledged or not will be that such institutions, in whole or in part, will be sheltered by access to a Federal safety net in time of crisis; they will be broadly understood to be “too big to fail”.
Think of the practical difficulties of such designation. Can we really anticipate which institutions will be systemically significant amid the uncertainties in future crises and the complex inter-relationships of markets? Was Long Term Capital Management, a hedge fund, systemically significant in 1998? Was Bear Stearns, but not Lehman? How about General Electric’s huge financial affiliate, or the large affiliates of other substantial commercial firms? What about foreign institutions operating in the United States?
Implicitly, through this Federal safety net that Paul Volcker refers to, those designated as TBTF will have an automatic premium to investment returns that small institutions or those not designated will not have. For instance, an stock investor is going to pick a TBTF with this implicit Federal safety net over a non-TBTF. It is that rational thing to do (LOL).
The choice is this: Do we want a financial sector that is a source of a huge portion of income and growth in our economy or do we want a financial sector that is a financial intermediary - a tool to allocate capital and resources.
Reason No. 3 - It will encourage more risk taking or less lending.
As Paul Volcker point out, this implicit Federal safety net may encourage TBTF institutions to take more risks particularly since their down-side is protected.
As for less lending, which is not necessarily a bad thing, this could be happening now. TBTF institutions could be anticipating these higher capital requirements and are hording the trillions of dollars in liquidity provided by the Fed and Treasury Dept. instead of providing loans. At the least, Richard Bove, a securities analyst seems to think so. The other argument is that TBTF balance sheets are so screwed-up that they need to recapitalize and can't originate any loans.
There are alternatives to the "New Foundation" proposal but they do require pissing off the financial oligarchy:
Alternatives to TBTF
1) Reinstate many of the 1930's regulations such as Glass-Steagall or as midtowng has argued eliminate laws such as Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, and the Depository Institution Deregulation and Monetary Control Act of 1980.
2) Require an internal firewall between proprietary trading and investment banking from commercial banking. Trading and investment banking must be funded with their own capital and not any capital from the commercial banking side.
We have to make banking boring again.