Refusing To Take Yes For An Answer On Bank Reform

By Simon Johnson

The debate over megabanks and – in the aftermath of the 2008 financial crisis – how to deal with all the problems associated with "too big to fail" in the financial sector has not been easy for many politicians.  The problems and potential real solutions do not map readily into the standard left vs. right divide in American politics.

The left generally wants the state to do more, and these days most of the right usually wants the state to do much less.  But in this space regulators are "captured", meaning that too many of them are effectively working to promote the interests of the big banks rather than to limit the dangers to the rest of us – so "more regulation" does not make much sense.  And these big banks have a strong incentive to get even bigger – it's their size that gives them economic and political power.  If you leave these banks to their own devices, they will become even bigger and blow themselves up at greater cost to ordinary citizens (see Western Europe for details).  So "no regulation" is also not an appealing proposition.

As a matter of presidential year politics, there is a remarkable convergence between President Obama and Mitt Romney, the Republican frontrunner.  Both think that we can tweak the rules to keep the banks from becoming dangerous.  The Obama administration calls their approach "smart regulation", while Mr. Romney has spoken of repealing the Dodd-Frank financial reform legislation (although his website is devoid of any further specifics).  But as far as anyone can see, their proposed approaches for the next four years are very similar – relying on the state to play a particular oversight role that has not gone well in recent decades.  They are both "statist" in this very particular sense.

The way to cut our Gordian financial knot is simple – force the big banks to become smaller.  Small banks and other financial institutions can be allowed to fail unencumbered by any kind of government bailout.  MF Global failed recently with about $40 billion in total assets; the shock waves did not bring on global panic.  A properly functioning market economy involves failure of this kind (although it is traumatic for employees and, in this specific case, also for many customers.)

A version of this idea was put forward by Democratic Senators Sherrod Brown and Ted Kaufman during the Dodd-Frank financial reform debate last year.  Their SAFE banking amendment would have put a hard size cap on the largest banks, relative to the size of the economy.  This amendment was defeated, 33-61, on the floor of the Senate.

From the right, Jon Huntsman has proposed essentially the equivalent idea.   He proposes a menu of options – presumably to give himself some room to negotiate with Congress – but his first idea is: "Set a hard cap on bank size based on assets as a percentage of GDP", where the specific cap seems very much in alignment with Brown-Kaufman.  He also proposes a hard cap on leverage and, as a complement to this, a punitive fee on bank size: "The fee would incentivize the major banks to slim themselves down; failure to do so would result in increasing the fee until the banks are systemically safe. Any fees collected would be used to reduce taxes for the broader non-financial corporate sector."

Not only is Huntsman advancing concrete proposals, he is also making it abundantly clear that these policies are the proper way to apply pro-market thinking.  His proposals also do not represent any kind of "move to center" (in the standard terminology of commentators).

The left does not like big banks because they represent an abuse of power by private individuals.  The clear-thinking right detests such banks even more – because they are supported by large, nontransparent, and very dangerous government subsidies.  There is nothing about the market in too big to fail banks – this is state capture, pure and simple.

Both sides should be able to agree that they have converged on this point.  The left (and the center) should be supporting Jon Huntsman for the Republican presidential nomination – at least as a way to push the banking reform agenda in a meaningful direction.

Some commentators on the right get this.  But important voices on the left hold back – perhaps refusing to believe that they can agree with an idea that also has support on the right.  Granted, it doesn't happen often – but this is one such opportunity to really make progress against a powerful and dangerous special interest.

On reducing the size of our largest banks, Senators Brown and Kaufman asked the question: Can we do this, reaching across the political aisle?  Their amendment was supported by a couple of Republican votes, including Richard Shelby, ranking minority member of the Senate Banking Committee.  Most of their supporters were Democrats.

But now Jon Huntsman offers a different answer and a definitive "Yes" on reducing the size of our largest banks.  If Huntsman becomes the Republican nominee – or even if he gets real traction in the upcoming primaries – the idea of reining in the size and power of megabanks could actually take hold within the Republican party.

Why won't people on the left see this opportunity and support it fully?

An edited version of this post appeared this morning on the NYT.com's Economix blog; it is used here with permission.  If you would like to reproduce the entire post, please contact the New York Times.