My Mind Is Made Up, Don’t Confuse Me With The Facts

Senator Elizabeth Warren was back in the news recently spinning her one issue platform (perhaps presidential) calling for the breaking up of Citigroup. In her reference to the breakup of Citigroup she said, “ We should have broken you up into little pieces when we had the chance.” What those pieces would be one can only wonder because Senator Warren hasn’t let us in on the specifics of her plan. Though she does seem sure that their sheer size is the problem of the major US banks. She went on to say, “Can someone pass something, anything to reign in these banks?” she pleaded in her news conference.”  Uh, Dodd Frank? Basel III? The new capital, leverage and liquidity rules are doing more to shrink the size of the major banks than Warren wants to admit or realizes.

Let’s step back and look at the effectiveness of the regulation that has been put in place since the 2008 crisis.  Dodd Frank (DF) had two major aspects to it: The Volker Rule and centralized clearing of swaps. Getting rid of prop trading at banks is a good thing. Nobody but Goldman has figured out how to do this successfully so Volker is probably saving the banks from themselves. The jury is still out as to whether centralized clearing of derivatives will reduce or increase risk.

Post-DF the Fed and the Basel committee have taken matters into their own hands and created a series of regulations that have had a real impact on controlling the size of banks and reducing their risk profile.  The alphabet soup of CET1, SLR, LCR and NSFR have been very effective at addressing issues like liquidity matching and forcing the banks to increase their capital base as they grow their balance sheets. These regulations are making the banking industry less susceptible to a crisis like 2008.  In the latest bit of regulatory piling on, the big banks are being asked to digest another layer of buffer equity called Total Loss Absorbing Capital (TLAC).

And that’s not all. The Fed’s Stress tests have become a year round exercises of prepare/submit/parse the results/repeat. The banks are also investing significant resources in the preparation of their resolution plans (Orderly Liquidation Authority or OLA). These plans detail how the bank can be wound down in an orderly manner in a time of financial stress (if something like that can really be modeled).

In Europe there are also other initiatives and changes underway to further reduce the risk of another major financial crisis. The Swiss have directed the restructuring of their banks to protect the commercial and retail banking clients from problems in their investment banking arms. Barclays and Credit Suisse are getting new CEO’s whose mandate may be to reduce the size of their investment banking operations. UBS and others have already begun scaling back their investment banks.

The press recently weighed in, on both sides, over the effectiveness of the new regulations.  Nathaniel Popper and Peter Eavis wrote an article (“New Rules Spur a Humbling Overhaul of Wall Street”, New York Times) highlighting the impact of recent regulation on profitability, staffing and the overall shrinking of the major banks. Still not everyone is convinced.  Jesse Eisinger offers up a hodgepodge of complaints about the government’s response to regulating the bank in another recent New York Times piece  (“Despite Changes, an Overhaul of Wall Street Fall Short”).  I’m not sure what is meant by “overhaul” but it is hard to argue that the recently imposed regulations haven’t significantly changed how banks conduct business.

However there is one troubling aspect to DF that was highlighted in recent op-ed piece in the Wall Street Journal (“A Financial System Still Dangerously Vulnerable to a Panic” by Glenn Hubbard and Hal Scott). The new rules will make it more difficult for the Fed and Treasury to act quickly in a crisis. Approval from congress and other agencies will be required before they can act. Nobody liked “bailouts” but rescuing the banking system saved the economy and the country in 2008. If it has to be done again constraining the Fed and Treasury could have serious consequences.

Back to Senator Warren’s call to break up the banks: What would be the plan? Glass Steagall Redux? A few bank analysts climbed on this bandwagon recently to analyze the value of breaking the large banks up into their component parts. Their motivation was more value creation than risk reduction.  The breakup of the big banks may or may not further reduce systemic risk and a reoccurrence of the 2008 crisis. It difficult to see this idea ever getting any traction.

Meanwhile the Fed and other foreign regulators continue to grind away, offering up additional regulations that are making real change and reducing risk in the banking industry.[1]  And what about Elizabeth Warren’s request that “…someone pass something, anything to reign in these banks?” My suggestion is she gives Fed Governor Tarullo a call and mix in a few facts with her populist rhetoric.

[1] The US and European regulators are engaged in an arms war, only this time the arms are capital, with each side, not to be outdone, continually upping the ante.

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