Treasury Secretary Timothy Geithner boasted on December 16 that 2008’s $700 billion bailout of an assortment of private enterprises would ultimately cost taxpayers less than congressional analysts had predicted. The green eyeshades had calculated that the enormous wealth transfer would end up docking us taxpayers a mere $25 billion. Without providing further detail, the secretary scoffed at the congressional bean counters’ estimates: “They are too high, in my judgment. Ultimately they’ll be lower.”
Geithner continued his victory lap in front of his congressional inquisitors: This federal largesse “will rank as one of the most effective crisis-response programs ever implemented.” And the government’s unconstitutional investment forays—its purchases of General Motors and insurance giant AIG—“will show a positive return.” Now we can all relax, comforted that the country’s financial infrastructure “is in a much stronger position than it was before the crisis.”
For the time being, the U.S. financial system might be healthier than it was in September 2008 when Lehman Brothers dissolved, the commercial paper market froze, and stocks plunged. It would be hard to surpass 2008’s brush with financial death. However, the federal government rode to the rescue as the markets burned because regulators deemed certain private market players—primarily banks—Too Big To Fail (TBTF). Under this theory, the collapse of any financial institution considered TBTF could have brought down the entire global financial system. The federal government, acting as lender of last resort, provided the necessary liquidity and credit support to forestall such a calamity. The tactic worked, and markets gradually returned to their artificial equilibria, despite the public row over bonuses to AIG employees and howls from Lehman Brothers, whose house of cards the federal technocrats, in their only laudable action, allowed to topple under its own weight.
But the banks that were TBTF in 2008 have now grown to become Too Big To Bail (TBTB), thanks to the government’s ad hoc crisis management. If JPMorgan was TBTF in September 2008, imagine how much more TBTF it is now that it has completed its government-assisted purchase of Washington Mutual, the largest bank in U.S. history to fail. And if Wells Fargo was TBTF in September 2008, imagine how much more so it is now that it has swallowed Wachovia to extend its octopus-like franchise to the East Coast. And if BankAmerica was TBTF in September 2008, what is it now that it has acquired both investment bank Merrill Lynch and Countrywide Financial, the mortgage lender that might have done more than any other private party to ignite the financial conflagration? The more Mr. Geithner crows about the successor gargantuan banks as one of “the most effective crisis-response programs ever implemented,” the likelier the U.S. financial system is to face its final test—proving that numerous financial institutions are now TBTB. These doddering institutions imperil the global financial system more than ever, even though no government technocrat will admit as much.
Take Bank of America, for example. Before stapling on Merrill Lynch and Countrywide, San Francisco-based Bank of America had merged with Charlotte’s NationsBank. Over the last few decades the two predecessor companies had purchased household names such as Boston’s Fleet Financial, Bank of Boston, Bank of New England and Shawmut, Boatmen’s Bancshares of St. Louis, Barnett Bank of Florida, LaSalle Bank of Chicago, California’s World Savings Bank, and credit-card issuer MBNA. And to bring the story full circle, in the early 1980’s the original predecessor bank acquired The Continental Illinois National Bank and Trust Company for a pittance when the Federal Reserve’s tight monetary policy, Mexico’s currency default, and falling oil prices imperiled Continental Illinois’s loan portfolio. Regulators coined a new phrase in 1984 when they judged Continental Illinois, with $40 billion in assets, “too big to fail.” As the aggregation of numerous TBTF institutions, Bank of America is now TBTB.
But Bank of America is not unique. All large American banks today resemble Russian matryoshka dolls. And now we can expect many of the country’s 7,650 small banks to be swallowed up as larger competitors use TBTF as an acquisition lever. With TBTF as the regulators’ guiding principle, investors will accept lower returns on capital invested in larger banks, knowing that regulators will never allow their investments to go belly up. Conversely, smaller banks will have to pay higher rates on capital needed to expand their operations to compensate for the risk that they might not succeed as business enterprises.
Consolidation has raged for two decades already. In the early 1990’s, the Federal Deposit Insurance Corporation supervised 16,074 banks. By 2000, its charges numbered only 10,222. And the resultant asset concentration in the banking system has become even more worrisome. In 1990, according to the New York Times, 32 percent of the nation’s banking assets resided at one of the 59 financial institutions with more than $10 billion in assets. Today, a mere 109 of these mammoth banks hold over 78 percent of the banking system’s total assets. FDIC Chairman Sheila Bair summarized the predicament best when she opined, “‘Too big to fail’ has become worse. It’s become explicit when it was implicit before.” Chalk up another dubious legacy to the crisis-response program of 2008.
What is to be done? First, as states and municipalities go hat in hand to Washington to fix their ballooning deficits, the federal government will have no grounds to deny rescue funds to local governments after it bailed out private enterprises in 2008. However, unless it revs up the printing presses, the government will have fewer spare dollars to deploy for the next private financial crisis. But when the next crisis introduces taxpayers to TBTB institutions, the point will be moot. Neither government regulation nor self-regulation by the banks will keep these financial behemoths in check. Only market regulation, with scorecards detailing profits and losses (we can call them “income statements” and “balance sheets”), will serve that purpose. The United States needs more Lehman-like suicides, in which regulators watch with disinterest, and fewer government-sponsored giveaways to the TBTB Leviathans—Bank of America, Wells Fargo, JP Morgan, et al.
Moral hazard has blinded the bankers. Hubris has blinded Secretary Geithner. Now the market must take off its blinders. It is the only party with any prospect of leading us out of the darkness.
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