It’s one of Democratic presidential candidate Bernie Sanders’ most ringing taglines about reforming the financial sector – “if a bank is too big to fail, it is too big to exist.” If elected, he claims, he would immediately establish a list of banks whose collapse would “pose a catastrophic risk to the US economy” and break them up within 365 days. But what are the broader economic implications of dismantling some of the nation’s largest financial institutions, and would seeing his plans through truly benefit the country?
America today, still reeling from the financial crisis,
bears striking resemblance to the America of the early 1930s. In response to widespread economic collapse following the stock market crash of 1929, Congress spat out the Glass-Steagall Act, which mandated the separation of commercial and investment banking activities in an effort to reduce commercial over-speculation. The GSA was perhaps one of the earliest recognitions that risky banking activities must be closely regulated to avoid potential catastrophe.
But like much of American politics, it didn’t work – the GSA was finally repealed in 1999 by the Gramm-Leach-Bliley Act after decades of lax enforcement. No longer facing regulatory firewalls between their various banking activities, financial institutions rapidly expanded their range of services, oftentimes through aggressive M&A activity. Since the early 1990s, 37 banks have become just four – Citigroup, JP Morgan Chase, Bank of America, and Wells Fargo – that now control $6.5 trillion in assets.
The crisis of 2008 was an indication that the financial
services industry has once again grown to a dangerous size. Banks were ramping up leverage and opacity through the proliferation of increasingly complex derivatives, and the degree of banks’ interconnectedness ensured that if one were to fall, others would surely feel the impact. To this day, banks assert that the riskiness of their positions is overstated as many of their derivatives strategically offset each other. But as the world has seen, a single wrong bet with enough leverage (i.e. the housing market) has the potential to drop the economy into free-fall.
Few substantive measures have been taken to prevent such a
catastrophe from reoccurring. As part of the convoluted and painfully inefficient Dodd-Frank Act, the Volcker Rule attempted to restrict banks from risky prop trading; however, the infamous JP Morgan “London Whale” incident in 2012 that resulted in a massive $6B trading loss proved that such legislation has been largely ineffective. Now the financial industry once again sits precariously on the same precipice that it did before the crisis, but this time the stakes may be even higher – the derivatives market is currently valued at roughly $700 trillion, more than 10 times the size of the world economy, and another mishap like 2008 would once again send the economy plummeting.
It’s time to take real action, and both consumers and the
government agree. Many top banks currently have PB ratios below 1, an indication of wavering investor confidence. The Federal Reserve has recently required banks to reserve a certain percentage of their total capital to cover their risk. And even some companies on “the fringe of Wall Street,” i.e. GE and MetLife, have begun divesting core business segments of their own accord.
There is not yet clear evidence that breaking up the banks
would be a better solution than simply restructuring them or setting additional regulations to limit the amount of risk they can take. After all, many assert that overall domestic economic growth is inextricably tied to the growth of the financial sector. But as it currently stands, I believe that steps of some form must be taken to limit banks’ power and risk before another financial crisis breaks out. -- Brendan Wu B.S. in Finance and Statistics Leonard N. Stern School of Business New York University | Class of 2018 email@example.com | 732-379-8088