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Fed’s appetite for TBTF destruction

By Claes Bell · Bankrate.com
Wednesday, March 21, 2012
Posted: 3 pm ET

The large national banks haven't won too many battles of late. They're facing a flood of new regulations, and they've been lambasted by customers, consumer advocates and politicians.

Now they've been singled out for destruction in an extensive essay by Harvey Rosenblum, executive vice president and director of research at the Federal Reserve Bank of Dallas. Rosenblum writes in the bank's 2011 Annual Report that the only way to prevent a future bailout is to break up banks that are "too big to fail," or "TBTF."

The Dallas Fed has advocated the ultimate solution for TBTF -- breaking up the nation's biggest banks into smaller units. It won't be easy for several reasons. First, the prospect raises a range of thorny issues about how to go about slimming down the big banks. Second, the level of concentration considered safe will be difficult to determine. Is it rolling things back to 1990? Or 1970? Third, the political economy of TBTF suggests that the big financial institutions will dig in to contest any breakups.

Taking apart the big banks isn't costless. But it is the least costly alternative, and it trumps the status quo.

A financial system composed of more banks, numerous enough to ensure competition in funding businesses and households but none of them big enough to put the overall economy in jeopardy, will give the United States a better chance of navigating through future financial potholes and precipices. As this more level playing field emerges, it will begin to restore our nation's faith in the system of market capitalism.

As Rosenblum notes, this isn't the first time the Dallas Fed has said this; Dallas Fed president Richard Fisher has said in numerous speeches that he supports breaking up TBTF institutions. But Rosenblum's essay looks more like a real policy statement, albeit one with no real specifics on how to get that done.

What would a government-led breakup of TBTF banks be like from a customer perspective? It might look something like the breakup of AT&T in the '80s. That process, known as the Bell System divestiture, created seven independent Regional Bell Operating Companies out of the original Bell monopoly. If the same approach were taken with banks and the regulators decided Citibank was just too darn big, they'd split it up into Citibank West, Citibank Atlantic, etc.

However, unlike with the "baby Bells," which enjoyed regional monopolies, I can see those regional banks having some serious issues with viability as separate businesses. Having the large national banks split up into chunks like that would be the worst of both worlds for customers. Not only would account holders have to deal with the generally higher price structure of the large national banks relative to small banks and credit unions, but the new regional banks wouldn't have the national reach and every-block convenience that's the main draw for large-bank customers.

Another possible way to do it would be to spin off the different divisions of large national banks, setting up, say, their investing and wealth management divisions as one entity and their retail banking and lending operations as another. That would avoid suddenly having their branch networks sliced into several pieces.

What do you think? Should large national banks be broken up? How would such a break-up affect customers?

Follow me on Twitter: @ClaesBell.

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