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Too big to jail: Can higher bank equity from Brown-Vitter help?

"Bart Naylor" "Financial policy reform"Under U.S. Attorney General Eric Holder, large banks enjoy immunity from criminal prosecution. In Senate testimony on March 10, Holder essentially confessed to Congress that giant bank HSBC was too big to prosecute, despite laundering $200 trillion (no typo) for terrorists, tyrants and narco-traffickers.  Financial havoc would supposedly ensue with a prosecution, according to this policy. Thus has begun the age of the too-big-to-jail bank.

The big banks brought us the financial crash of 2008 because bankers took undue risks. Policy makers deemed these banks too big to fail. Consequently, banks and their creditors were bailed out, while shareholders were mostly wiped out and taxpayers were hung out.

The newly articulated Holder policy of “too big to jail” means that moral hazard has metastasized from merely propping up mismanaged banks to blocking prosecution of criminally managed banks.  Too big to fail now extends to too big to jail. We’ve written before about this moral hazard. Bankers can dismiss the meek penalties from the Department of Justice as library fines.

Help may be on the way. Known as “Brown-Vitter” for sponsoring Sens. Sherrod Brown (D-Ohio) and David Vitter (R-La.), S. 100, the Terminating the Expansion of Too-Big-To-Fail Act of 2013, increases the amount of shareholder equity required for the largest banks. Minimum shareholder equity would be raised from the current 4 percent to 15 percent.  That means more shareholder money could be burned by bad management.  Bankers generally oppose higher capital requirements because it reduces leverage opportunity.  Any speculator would rather put down 4 percent of his own money and borrow the rest because a subsequent 4 percent increase in price means the equity investment is doubled. At 15 percent, it takes that much more in gains to double one’s money.

In addition to creating a larger prudential financial “cushion,” raising shareholder equity would intensify oversight from shareholders. Shareholders are the owners of companies and, collectively, they have the most at stake in the businesses’ performance.   Shareholders can theoretically replace board members through annual meeting votes.  And shareholders grade management minute by minute through the share price, which, in turn, helps determine management pay.

Corporate managers may have uneasy relationships with their shareholder-bosses. For example,  JPMorgan Chase set up a war room to stop shareholders from revoking CEO Jamie Dimon’s privilege of serving as his own boss as chairman of the board.

Bankers like the leverage opportunity of low shareholder equity so much and greater shareholder oversight so little that they’ve launched a spirited campaign to stop Brown-Vitter.  Wells Fargo, one of the five largest banks, retained political consulting firm Penn Schoen Berland to test arguments with Washington, D.C. banking experts.  (They called Public Citizen.)  Politico reported on a personal charm campaign wherein the CEOs of JPMorgan and Goldman Sachs granted audiences to freshmen Democrats on the House financial services committee. Campaign contributions from the mega-banks are rising.

Brown-Vitter takes only one necessary step to combat the moral hazard of too-big-to-jail banking policies.  Momentous judicial decisions should take place in full public view, which did not happen in the HSBC debacle. Greater transparency should be required to reveal any instances in which the Department of Justice decides to pull its punches because of a bank’s size.

For the present, it is gratifying that the Wall Street lobby has something useful to complain about, instead of promoting the evisceration of Wall Street reform law. Thank you, Sens. Brown and Vitter, for picking a good fight.

Bartlett Naylor is the financial policy reform advocate for Public Citizen’s Congress Watch division. Follow him on Twitter at @BartNaylor.

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