Too Big to Run

By / 12.3.2009

In discussions about the dismal state of the economy, the existence of “too big to fail” institutions has emerged as a recurring cause for concern. In particular, Bank of America and Citigroup (the first and third largest banks in the country, respectively) are firms whose size makes them an “existential threat” to the well-being of the economy.

(Bank #2 in size is JPMorgan, whose chief, Jamie Dimon, has been going around saying that we can end “too big to fail” without capping the size of financial institutions by providing regulators with resolution authority over banks — the ability to wind them down in an orderly fashion. While resolution authority can help in cases — like Lehman’s — where banks become insolvent, these after-the-fact measures would not prevent the liquidity crisis that selling against a too-big-to-fail institution would cause.)

While Citigroup has made efforts to break itself up, including selling off its half of the Smith Barney joint venture with Morgan Stanley, Bank of America under Ken Lewis has been resistant to downsizing, adamant that clients benefit from its size. But with the embattled Lewis having announced he will step down at the end of the year, the bank is looking for a new chief.

And that search has run up against a problem — not only are these firms seen as “too big to fail,” they’re also too big to run:

At least two candidates for the top job at Bank of America Corp. told directors that the giant bank should consider breaking itself up… [One candidate, former Bank of Hawaii CEO Michael O’Neill] recently told the Bank of America search committee that the bank’s risk-adjusted capital wasn’t being used productively. He added that the company should become simpler and less prone to volatility

How big is Bank of America? With over $2.25 trillion in assets, it has a pervasive presence in our economy. The numbers from the Wall Street Journal are staggering:

Bank of America is the largest U.S. bank by assets and has 6,000 branches, 18,000 automated-teller machines and relationships with 53 million households, or roughly one out of every two households in the U.S.

Whereas the mantra “bigger is better” was applied to the financial industry over the past 20 years, there is now a reassessment of that idea. But instead of providing clear guidance on how to get financial institutions to a more reasonable size (and, indeed, what that size is), the government is sending unclear signals, with conflicting announcements on which companies it is willing to bail out and tepid additional reporting requirements that won’t rein in outsized firms.

Rather than add to the uncertainty, the administration should come out with guidelines on how it proposes to solve the “too big to fail” problem. Whether through voluntary break-up of banks it has a stake in, anti-trust measures, or by instituting a too-big-to-fail tax, the administration should lay out clear rules for banks to follow. This will allow big banks to stop chasing their tails on executive decisions — like Bank of America is doing — and get back to business.