Wall Street Reform is Working

Last April it was General Electric. Now it's MetLife.

Forget too-big-to-fail.

The operative question for the country’s largest financial firms is increasingly whether the government has made it too expensive to be big.

On Tuesday, insurer MetLife Inc. became the second major firm in the past 10 months to decide that the demands of being “systemically important” in the eyes of regulators may outweigh the benefits of continuing to operate at its current size...

The moves show that while the U.S. government hasn’t heeded populist calls to “break up” the nation’s largest financial firms, those demands are at times being answered through indirect pressure from regulators.

Here's what is happening. One of the provisions in the Dodd-Frank Wall Street reform bill is to identify "Systemically Important Financial Institutions" (SIFI, another way of saying "too big to fail"). Those institutions now have to abide by special regulations, one being that they have to maintain enough capital to cover their risky bets (so that taxpayers are not required to bail them out). Doing so makes them less profitable.

In the banking sector, where policy makers have focused the toughest rules on roughly 30 banks with $50 billion or more in assets, smaller banks with between $5 billion and $50 billion in assets are about 10% more profitable than banks that are above that level, according to an analysis by Keefe, Bruyette & Woods. The shares of those midsize banks accordingly trade at a higher valuation than lenders with $50 billion or more in assets, according to the analysis.

That's why some of them are downsizing. Next up could be Prudential Life and AIG (whose impending demise is what sparked the 2008 bail-out).

But these SIFI's are facing other Dodd-Frank regulations.

Another major test looms in the coming weeks when regulators have to decide whether 12 top banks have credible plans describing how they could fail without a bailout—dubbed “living wills”—or whether to begin pressing those firms to simplify or shrink.

Policy makers say they aren’t explicitly telling firms to break up, but they also make clear they wouldn’t be unhappy with that outcome.

Americans still harbor a lot of anger at the way these institutions created havoc in 2008. But for those who are as interested in solutions as they are in being angry, Wall Street reform is actually working.