Originally published in the New York Times
LAST week, Sanford I. Weill, the mastermind behind the creation of the colossus now known as Citigroup, shook the New York-Washington axis by calling for the dismantling of megabanks. It was as if John D. Rockefeller had proposed the breakup of Standard Oil.
But Mr. Weill’s musings are an ill-advised distraction. Instead of focusing our attention on the worrisome risks that remain, four years after the financial crisis, he diverted attention to a tiresome debate over whether the Glass-Steagall Act, the 1933 banking law that separated commercial banking from investment banking, should be reinstated.
A bit of recent history: none of the institutions that toppled like dominoes in 2008 — the investment banks Bear Stearns and Lehman Brothers, the mortgage-finance giants Fannie Mae and Freddie Mac, the insurance company American International Group — were commercial banks.
So the bank merger frenzy that Mr. Weill set off in the late 1990s was not the proximate cause of the financial crisis. Nor was the concentration of our banking system, which is less centralized than those in Britain, France, Germany, Italy, Japan, Switzerland and many other countries.
What brought our financial system to its knees was old-fashioned poor management that expanded the banks’ portfolios and activities too aggressively without sufficiently robust risk controls, enabled by lax (or nonexistent) oversight by regulators. Many of those excesses were concentrated in the housing sector, where a now legendary bubble formed without regulators or industry leaders recognizing it.
When the bubble inevitably deflated, in 2007, the weakest institutions imploded with it, and systemic risks were exposed. Only with billions of government money — much of it now happily recouped — was the system saved.
Out of that disaster came significant improvements. Balance sheets and risk controls were strengthened. Regulatory scrutiny was beefed up. The Dodd-Frank overhaul of financial regulation became law in 2010. A shaken world exhaled.
But because of flaws in Dodd-Frank, the possibility of future catastrophic failures has not been eliminated, nor would it be by Mr. Weill’s proposal.
Most important, Congress buckled to vested interests and failed to revamp the dizzying and overlapping patchwork of an alphabet soup of agencies that regulate financial institutions. Just one minor agency was eliminated and a new, unwieldy oversight council was placed above the ungainly mess.
Because of pressure from Sheila C. Bair, then the chairwoman of the Federal Deposit Insurance Corporation, the primary responsibility for winding down failing institutions was given to the F.D.I.C., an agency woefully ill equipped to deal with complex global entities. The Federal Reserve Board would have been a far superior choice.
In April 2011, the F.D.I.C. published a hypothetical plan suggesting that it could wind down a global octopus like Lehman in a manner similar to the way in which it routinely takes over small community banks. The report was widely derided.
We need a Dodd-Frank do-over to create the right oversight apparatus for huge banks. Regulators will always be outnumbered by bankers, and they will never find every problem. But, like prison guards, regulators are essential, even if they are outnumbered. In a world of behemoth banks, it is wrong to think we can shrink ours to a size that eliminates the “too big to fail” problem without emasculating one of our most successful industries.
Dodd-Frank did set out some sensible principles for dealing with systemically important banks that are endangered. Bondholders and shareholders would bear severe or even total losses. Management and directors would be replaced. Other concepts, however, need to be clarified and made more flexible. Failing institutions should not necessarily be liquidated; reorganization often preserves more jobs and more value than dissolution, as the reorganizations of General Motors and Chrysler proved. Also, regulators haven’t been sufficiently clear about whether a failing bank’s counterparties — the institutions on the other side of every derivative transaction — would be forced to take losses. If they were, that could risk a panic like that of 2008, when financial institutions fled from doing business with one another.
Good management will always be more effective in avoiding bad outcomes than legislation, as Mr. Weill should know. Citigroup would have been managed soundly and would not have needed a $45 billion bailout if he had not capriciously dismissed his talented protégé Jamie Dimon (who has done an extraordinary job at JPMorgan Chase, notwithstanding its recent trading losses).
Happily, Dodd-Frank includes a rule, proposed by the former Fed chairman Paul A. Volcker, that forbids banks to gamble with insured deposits. We should focus on putting this and other new regulations into effect, and devising better ways to deal with financial giants — not distractions like Mr. Weill’s call for reinstating an outmoded concept like Glass-Steagall.
