Are the Banks Too Big to Fail, Manage and Regulate?
Business + Economy

Are the Banks Too Big to Fail, Manage and Regulate?

REUTERS/Jonathan Ernst

Treasury Secretary Timothy Geithner’s admission on Wednesday that he failed to blow the whistle on the Libor scandal and former Citigroup chairman Sandy Weill’s call to break up the banking behemoths seem at first blush to have little in common.

But they are, in fact, two sides of the same coin.

Weill admitted on CNBC’s Squawkbox that the 1999 repeal of the depression-era ban on combining lending banks with investment banks failed by creating institutions that are too big to manage and too big to fail.

“What we should probably do is go and split up investment banking from banking,” Weill said in televised comments that ricocheted around financial markets and the Internet throughout the day. Weill was one of the original gravediggers for Glass-Steagall when he engineered the merger of Citibank and Traveler’s Insurance in 1998.

“Have banks be deposit takers, have banks make commercial loans and real estate loans,” he said. “And have banks do something that is not going to risk the taxpayer dollars, that’s not going to be too big to fail.”

As members of the House Financial Services committee were digesting that bombshell, they turned their attention togrilling Geithner on the same question that had been aimed at Federal Reserve Board chairman Ben Bernanke last week. What did he know at the New York Fed in 2008 and when did he know about the interest-rate rigging that took place among some of the 15 banks (including three from the U.S.) that self-report their interbank lending rates to the British Bankers Association.  

Banks that had become too big to manage and too big to fail had also become too big to regulate at the micro-economic level.

Members from both political parties wanted to know why Geithner never demanded the Department of Justice launch an immediate investigation or cancel its own borrowings based on Libor, the acronym for the London Interbank Offered Rate. Geithner repeatedly answered: We told the BBA and we told the regulators on both sides of the Atlantic, including their investigative arms.

And then, he said, the Federal Reserve Board and Treasury went about their main business at the time – rescuing a banking system that was collapsing from lending and derivatives practices that had nothing to do with Libor.

In other words, regulating the banks – being the cop on the beat, so to speak – played second fiddle to the macro-economic need to preserve the financial system in the midst of a crisis. Banks that had become too big to manage and too big to fail had also become too big to regulate at the micro-economic level.

“I did not” inform the Department of Justice about possible criminal wrongdoing, Geithner said in response to a direct question from retiring Rep. Brad Miller, D-N.C. Instead, Geithner wrote a detailed memo to the British banking authorities on how to improve the reporting system to avoid rate-rigging.

“You used it as something akin to jaywalking rather than highway robbery,” fumed Rep. Jeb Hensarling, R-Tex. “Never once did you come before this committee during the Dodd-Frank discussions” to discuss the Libor issue, said Scott Garrett, R-N.J. “Now it comes out that it’s the crime of the century and you did nothing about it.”

Some Democrats defended Geithner’s limited response, pointing out that the British regulators had direct responsibility and failed to curb the abusive practices reported to the New York Fed and leaked to the financial press. “Because British bankers and regulators screwed up, we have to blame someone an ocean away – and preferably of the other political party,” said Rep. Brad Sherman, D-Cal. “I’m not one in the blame America first crowd.”

Do regulators have the manpower to oversee institutions whose operations have become so complex that even their top managers are in the dark?

The posturing on Capitol Hill raises a serious issue, though. Do the regulators at the Fed, Treasury, Federal Deposit Insurance Corporation, Office of Thrift Supervision, the Securities and Exchange Commission and the Commodity Futures Trading Commission – that fragmented regulatory complex that oversees different aspects of the convoluted U.S. financial system – have the manpower to oversee institutions whose operations have become so complex that even their top managers are in the dark about day-to-day operations that may be putting the bank and perhaps the financial system at risk?

JPMorgan Chase’s James Dimon has testified that he was unaware about trading practices at his bank that led to what has grown to a $6 billion loss, initially reported at $2 billion earlier this year. Barclay’s Robert Diamond resigned this month after his bank paid $453 million to settle allegations of Libor rate-rigging that he claims he knew nothing about. HSBC, the largest British bank, is ensnared in a scandal that could lead to billions in damages for allowing drug runners and terror organizations to move money through its branches.

While the latter two involve British banks, U.S. regulators had over 100 personnel inside JPMorgan Chase conducting oversight activities. None picked up the rogue trading by the so-called “London whale.”

“We have to increase the size of the regulatory agencies,” Geithner said. “Imagine a town whose population increases in size by ten times. You’re going to have to increase the size of the police department.”

Congress has been quite stingy in that regard. The huge U.S. debt has prevented action on beefing up the regulatory force. But even with more hands on deck, would the regulators be able to effectively oversee institutions whose complex businesses involve trillions of dollars in assets in multiple lines of businesses? Would breaking up those institutions make sense, not just to reduce systemic risk, but to make them more transparent to specialized overseers?

The ink is dry on the Dodd-Frank financial services reform bill. But numerous rules are on hold as the financial services behemoths and their political allies at organizations like the U.S. Chamber of Commerce claim full implementation will choke off lending and business. They are especially opposed to implementation of the so-called Volcker rule, which would prohibit banks from engaging in proprietary trading activity. Republicans have pledged to repeal most of the law should Gov. Mitt Romney win election and they gain control of both houses of Congress.

But a more populist approach along the lines suggested by Weill could win bi-partisan support in a new Congress. Rep. Walter Jones, R-N.C., told Geithner that his vote to repeal Glass-Steagall 13 years ago one of the “two worst votes I made in my career,” the other being his 2003 vote in favor of the Iraq War. He is now co-sponsor of a bill with Rep. Marcy Kaptur, D-Ohio, that would once again prevent banks that take guaranteed deposits from engaging in investment banking activities.

“Isn’t it time to have a discussion and a debate about reinstating Glass-Steagall,” Jones said.