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PROGRESSIVES and conservatives can debate the proper role of government, but this is one principle on which we can all agree: The government shouldn't pick economic winners or losers.
In 2008, at the height of the financial crisis, the government stepped in and decided which Wall Street banks were so large and interconnected that they would receive extraordinary help from the government to enable them to survive. They were deemed, to use a now ubiquitous phrase, too big to fail. Meanwhile, smaller banks in communities across the country, including Cleveland and Covington, La., in the states we represent, were allowed to fail. They were, evidently, too small to save.
Today, the nation's four largest banks — JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — are nearly $2 trillion larger than they were before the crisis, with a greater market share than ever. And the federal help continues — not as direct bailouts, but in the form of an implicit government guarantee. The market knows that the government won't allow these institutions to fail.
It's the ultimate insurance policy — one with no coverage limits or premiums.
These institutions can then borrow and lend money at a lower rate than regional banks, Main Street savings and loan institutions, and credit unions. This implicit taxpayer subsidy has been confirmed by three independent studies in the last year; one of them estimated it at $83 billion per year. We have, in essence, a financial system that rewards banks for their size, not the quality of their operations. It's a "heads the megabanks win, tails the taxpayers lose" scenario, one that discourages innovation and competition and is distinctly un-American.
How did we get here? When the government established the Federal Reserve in 1913 as a lender of last resort, to mitigate the severity of financial panics, and then, 20 years later, created deposit insurance in response to the Depression, those protections were intended for commercial banks that provided savings products and loans to American consumers and businesses. At that time, most banks had shareholder equity equal to 15 to 20 percent of their assets.
In the ensuing decades, the expanding federal safety net allowed financial institutions to depend less and less on their own capital. Federal support was stretched far beyond its original focus, as successive generations of lawmakers and regulators allowed financial institutions to enter the business of insurance, securities dealing and investment banking.
We want to reverse this dangerous trend with bipartisan action aimed at ending "too big to fail" in a practical, responsible fashion. On Wednesday, we will introduce legislation to ensure that all banks have proper capital reserves to back up their sometimes risky practices — so that taxpayers don't have to. We would require the largest banks to have the most equity, as they should.
Our bill aims to end the corporate welfare enjoyed by Wall Street banks, by setting reasonable capital standards that would vary depending on the size and complexity of the institution. Economic and financial experts on both the left and the right agree that capital is a vital element of financial stability. Adequate capital levels lower the likelihood that an institution will fail and lower the costs to the rest of the financial system and the economy if one does.
Unfortunately, existing capital rules are insufficient to prevent another crisis and are either too complex to administer or too easy to manipulate. Andy Haldane, the executive director for financial stability at the Bank of England, has estimated that an average large bank would have to conduct more than 200 million calculations to figure out whether it meets the capital regulations under the so-called Basel II framework, a set of international standards that banking regulators use to determine how much capital banks need at their disposal to guard against risk.
A new set of standards known as Basel III is still being implemented. But it would take years to finalize, and even the new proposed standards are too weak: in many scenarios, for every $1 of equity a bank used, it could borrow $24. That means that the bank could become insolvent if its assets declined by as little as 4 percent. As we know from the housing meltdown, that is far too narrow a margin of error.
Senators Sherrod Brown, Democrat of Ohio, and David Vitter, Republican of Louisiana, are members of the Senate Banking Committee.
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