I agree with James Pethokoukis of AEI: Mitt Romney should make an affirmative case for banking reform. One challenge with rolling out new initiatives is that nuance tends to get lost in the heat of the campaign. Romney has benefited mightily from concerns about Dodd-Frank, which The Economist addressed in some detail back in February. So while it has been relatively easy for him to promise to repeal Dodd-Frank, articulating an alternative set of financial reforms is more of a challenge.
Pethokoukis has called for breaking up America’s largest financial institutions. Frank Keating, the former Republican governor of Oklahoma who now heads the American Banking Association, objected to Pethokoukis’s article, arguing instead that what we need are stringent “if you fail, you lose” policies. The trouble, of course, is that it is hard to imagine Congress allowing systemically-important, too-interconnected-to-fail institutions to fail, which is why a number of libertarian-minded scholars, including Jonathan Macey of Yale Law School, have called for fairly radical solutions. As Macey and his co-author James Holdcroft Jr. have put it:
Political theory and historical experience show that politicians facing unsettled capital markets and highly anxious voters will always bail out the financial institutions that they deem “Too Big To Fail.” As such, the only way for government credibly to commit to refrain from pursuing a Too Big To Fail policy is to break up the largest financial institutions before they become Too Big To Fail. We identify the size at which we believe banks become Too Big To Fail. Banks that reach this size should be broken up. Liabilities should be limited to a metric based on the actual funds devoted to resolving failed banks. The metric that we identify is the targeted value of the FDIC’s Deposit Insurance Fund. We would prohibit any financial institution from amassing liabilities in an amount greater than five percent of the targeted value of this fund. The government could thereby commit credibly to stopping bailouts and to pursuing a policy of allowing financial institutions to fail. We believe that the lost economies of scale associated with this “ersatz-antitrust policy” would be offset by the large savings realized by avoiding future bailouts.
Interestingly, Mark Calabria has offered a related — albeit far less radical and heavy-handed — idea, i.e., strictly limiting “the share of insured deposits that can be held by any one bank”:
If the ultimate concern is risk to the taxpayer, due to the backing of the Federal Deposit Insurance Fund, then it would seem to be that the obvious answer, and easy to implement, is to limit the amount of insured deposits that can be held by any one bank. The previous limit was 10 percent of the insurance fund, although that could be breached by organic growth (rather than via merger). We should reduce the limit to 5 percent and make such a hard cap. If banks want to take uninsured deposits that’s fine, as long as we limit the risk to the FDIC.
Both ideas are, I suspect, unlikely to attract much support from mainstream Democrats or Republicans. But that might change, particularly if we experience another financial crisis in the next few years, as seems all too likely.