Breaking Up (Banks) Is Hard to Do

The latest Wells Fargo bank scandal has rekindled debates about breaking up banks that are too big to fail, too big to manage or too big to comply.

Echoing the debate between Louis Brandeis and Teddy Roosevelt in the Progressive Era, politicians propose either to break up our huge banks — as Brandeis advocated — or to regulate them, which was Roosevelt’s position. Most Republican presidential primary candidates argued that, while the Dodd-Frank financial reform law overregulates small community banks, the law did not go far enough to eliminate the threat that the huge banks are too big to fail and will inevitably be bailed out in a future crisis. On the Democratic side, Bernie Sanders played the role of today’s Brandeis, while Clinton seems more aligned with TR. The candidates seemed unanimous in the belief that Dodd-Frank did not go far enough to address the hugeness of the megabanks.

Without new laws passed by Congress, what power would a new President and presidential appointees have to break up banks that are too big to fail?

The answer is, not much. Dodd-Frank limits additional growth and market power of the too-big banks, known as systemically important financial institutions (SIFIs), but grants the power to break up banks in only very limited situations. Most of that power is in the hands of the Federal Reserve Board or other bank regulators who serve fixed terms rather than being appointed at the will of the President. The Treasury Secretary is one of nine members of the Financial Stability Oversight Council (FSOC), but that body has mostly advisory powers.

Dodd-Frank allows involuntary breakups only for a financial institution in actual default, i.e. unable to pay its bondholders or depositors, under the orderly liquidation authority (OLA). The idea behind the OLA is that any bank, no matter how big, can be allowed to fail, and the OLA is a roadmap to reorganize or liquidate the failed bank. The OLA procedure does not offer any way to break up a bank that has not already failed.

Dodd-Frank does have a variety of industry concentration limits that affect additional bank growth.  One is embodied in the Fed’s new Reg XX, which prevents one bank from acquiring another  if the resulting bank would have more than 10 percent of the total deposits and other liabilities owed by all banks. Concentration limits, however, don’t provide any means for divesting past mergers and acquisitions.

Even before Dodd-Frank, the federal bank regulators had the power to order divestments, in the context of bank safety and soundness reviews, but only on the grounds of risk to the banks’ own depositors and creditors, not based on broader systemic risk (and certainly not based on repeated consumer protection violations, excessive political power or influence over regulators.)

The closest Dodd-Frank came to authorizing breakups of megabanks because they are too big to fail was Section 121 (the Kanjorski amendment). It allows the Federal Reserve Board, with the approval of two-thirds of the FSOC, to compel a break-up and divestiture of high-risk parts of a bank or financial institution if it poses a “grave threat” to the financial stability of the United States. The current Fed chair, Janet Yellen, is serving a four-year term that ends in 2018, and the other members of the Federal Reserve Board of Governors serve staggered 14-year terms. The FSOC has a few presidential appointees on it but a majority of its members cannot be removed at the will of the President. The President therefore has little ability to appoint those who have the power to enforce the Kanjorksi amendment, which was obviously the product of intense lobbying by the banks to make it extremely difficult to ever break up a bank solely because its size poses a systemic risk.

There are a few other possible tools to break up megabanks in Dodd-Frank.  A SIFI that fails repeatedly to submit its “living will” plan for orderly liquidation can be ordered to divest, under Section 165(d). Last April, regulators rejected the living wills of five major banks, and ordered them back to the drawing board, , and the banks resubmitted their new and improved plans on October 4..  It remains to be seen whether the regulators will accept these new plans, or resort to the nuclear option of ordering divestments.

Simply being designated a SIFI can nudge institutions (like General Electric or MetLife) to break themselves up to avoid stricter regulatory capital and other rules, but that depends mostly again on independent bank regulators toughening the rules that govern the SIFIs. The Fed recently suffered a setback when a federal district court overruled its designation of MetLife as a SIFI.

In short, breaking up the too-big-to-fail banks will probably require the new President to get new legislation through Congress.

In a recent article, available here, I make the case for rethinking bank regulation on a public utility law model, which would allow regulators to restructure the banking industry, including through vertical and horizontal break-ups. I argue that banks provide essential infrastructure services, are heavily dependent on a variety of taxpayer subsidies and guarantees, and should be subject to more intensive supervision, not just to insure safety and soundness but to advance other public goals, as we do now with energy, transportation, and telecommunications companies.

This post comes to us from Professor Alan M. White of CUNY School of Law. It is based on his recent paper, “Banks as Utilities,” available here.