Radio Shack. Borders Books and Music. Blockbuster Video. Eastman Kodak.
These are the names of companies that once dominated their industries that have gone the way of the Dodo. Their bankruptcies caused thousands of job losses and wiped out shareholders. Yet, there was no successful clamor among the public or policy makers to bail out any of these corporations. As big as they once were, these firms were not deemed Too Big to Fail. If only it were so in the financial industry.
Five years after the Dodd-Frank financial reform law was enacted, Too Big to Fail banks are more entrenched than ever. Yet most “fixes” miss the heart of the problem. Firms only become Too Big to Fail when there is a lack of competition from new entrants.
The financial crisis that swept across the country and the world starting in 2008 hit many American industries hard. Yet financial services was virtually the only sector that was given a lifeline by the government (along with the piggybacking of General Motors and Chrysler onto the Troubled Asset Relief Program).
Despite is prevalence, Too Big to Fail, the doctrine that some firms must be bailed out to save the broader economy, is still the exception rather than the rule. And in looking to end it, the question that must be asked is what makes the financial industry, as it is structured today, so “exceptional.”
Unlike with virtually every other industry, government regulators are essentially hanging a sign outside their windows stating, “No new banks need apply.” New regulations imposed since the financial crisis—including but not limited to Dodd-Frank—have created a de facto moratorium on the approval of new banks. Since 2010 only one new bank has been approved by federal regulators, the Bank of Bird-In-Hand in the Amish country of Pennsylvania.
It is not just small startups that have been shut out of the financial market, but also innovative firms that have proven themselves in sectors from retailing to manufacturing. Unlike virtually every other industrialized country, the U.S. effectively bans non-financial corporations from owning bank affiliates. This means the best-run American corporations, with expertise in areas important to banking like technology and supply-chain management, are locked out of the banking industry. In the past decade, both Walmart and Berkshire Hathaway have tried and failed to get regulatory approval to create banking units.
This lack of new entrants is one important reason why a large bank failure could severely curtail the supply of credit and availability of financial services. That in turn sets the stage for a continuing cycle of bailouts.
Since the financial crisis, the debate about bailouts and Too Big to Fail has been dominated by proposals to limit what traditional banks can do, and increasing capital requirements, to supposedly lessen taxpayers’ exposure to risk. Dodd-Frank put limits on banks’ use of certain types of derivatives and proprietary trading. And there is a bipartisan chorus in Congress calling for restoring the Glass-Steagall Act, which separated commercial and investment banking until it was partially repealed by the Gramm-Leach-Bliley Act, signed by President Bill Clinton in 1999 with strong bipartisan support. Yet such restrictions are largely counterproductive, both in creating more stability for the financial system and in reducing the concentration of the biggest banks. The proprietary trading limits in Dodd-Frank’s Volcker Rule, for instance, have wreaked havoc among regional and community banks.
To really tackle Too Big to Fail, the discussion needs to broaden to opening financial services to new types of entrants that can bring the technology and management expertise of both startup businesses and leading American firms to the banking field. In the financial industry, as in any other industry, greater competition can help bring stability, innovation, and choice.
Congress should put in place procedures for new bank approval, in which regulatory agencies would have a specified time limit to approve or deny new bank applications. If regulatory agencies exceed these time limits, they should be required to give the bank, Congress, and the public detailed explanations as to why this was the case. Congress should also end the outdated and absurd regulatory doctrine of separation of banking and commerce by repealing the Bank Holding Company Acts of 1956 and 1970.
It is time to bring what the great economist Joseph Schumpeter called “creative destruction” to the banking industry, by bringing in the competition from new entrants that exists in every other industry. There’s no banks like new banks.