Too Big to Fail Banks Are Shrinking

One of the issues populists on the left like Senators Elizabeth Warren, Bernie Sanders and Sherrod Brown are raising is that we need to break up the big banks that were primarily responsible for the financial crisis because Americans don't want to be on the hook for further bailouts of "too big to fail" financial institutions.

Their contention is that the Wall Street reforms contained in Dodd/Frank didn't go far enough. But it looks like perhaps they should have been more patient.

Global regulators have issued dozens of rules aimed at making the biggest banks safer. That’s leading to another result some wanted: making them shrink...

Increasingly strict capital rules over the past three years may be forcing the breakup of the financial supermarkets built in the decade before the financial crisis. Lenders, unable to use borrowed money to fund as much of their business as they once did, have cut profitability targets and are weighing more drastic actions to meet them.

“We’re beginning to see discussions that these capital charges are sufficiently large it’s causing those firms to think seriously about whether or not they should spin off some of their enterprises to reduce their systemic footprint,” Federal Reserve Chairman Janet Yellen told the House Financial Services Committee on Wednesday. “And frankly, that’s exactly what we want to see happen.”...

“They are saying we’ve got to go back to a much safer system and that means everyone needs to shrink,” said David Ellison, a Boston-based money manager at Hennessy Advisors Inc., which oversaw $5.9 billion at year-end. “They are using Basel, the CCAR stress test, to say this is what we want you to do. They have effectively nationalized the banking system.”...

There’s nothing in Dodd-Frank or the global capital rules that tells banks to break up, according to Thomas Hoenig, vice chairman of the U.S. Federal Deposit Insurance Corp. The law says they should be capable of being wound down in a crisis, which is pushing some firms to shrink, he said.

“We’re not going to break you up, but we want you to structure yourself so that your failure doesn’t bring the economy down next time,” Hoenig said. “If you can’t get to that point with your current organization structure, then you should sell assets to get to that state.”

That message is finally getting through.

Rather than take over the banks and/or force them to break up, the reforms included in Dodd/Frank have incentivized these financial institutions to downsize themselves. As I've written about before, that's the kind of big organizational change that actually works.

The farther out we get from the panic of the original crisis and the passage of these reforms, the better former Treasury Secretary Tim Geithner looks. His goals were to create a "soft landing," protect American taxpayers, and do what was necessary to prevent this kind of crisis from happening again. It may be taking a while to play out, but that's exactly what is happening.