With a brand new proposal, Republican presidential candidate Jon Huntsman is the only GOP 2012er to have moved beyond “repeal Dodd Frank” (which sounds like a return to the status quo) and fashioned a serious and comprehensive — and bold — financial reform plan. He’s for repealing Dodd Frank, of course, but also a) reducing bank leverage by axing the deduction for interest payments and b) shutting down Fannie and Freddie.
But eliminating “too big to fail” is really the core of what he’s trying to do. As Team Huntsman correctly notes, the six largest U.S. financial institutions are significantly bigger than they were before the financial crisis. These banks now have assets worth over 66 percent of gross domestic product—at least $9.4 trillion, up from 20 percent of GDP in the 1990s. And the major banks’ too-big-to-fail status gives them a huge advantage in borrowing over their competitors. This funding subsidy amounts to at least 25 basis points and perhaps as much as 50 basis points. Indeed, that edge is proof TBTF still exists.
We need banks that are small and simple enough to fail, not financial public utilities. Hedge funds and private equity funds go out of business all the time when they make big mistakes, to the notice of few, because they are not too big to fail. There is no reason why banks cannot live with the same reality.
Here’s how Huntsman wants to kill TBTF and break the crisis-bailout-crisis-bailout cycle:
1. Set a hard cap on bank size based on assets as a percentage of GDP. (This cap would be on total bank size, not using any of the illusory “risk-weights” currently central to thinking about bank accounting. The lowest risk assets for banks in Europe, supposedly, are sovereign debt—yet this very same debt is now at the heart of the current crisis.
2. We should have a similar cap on leverage—total borrowing—by any individual bank, relative to GDP.
3. Explore reforms now being considered by the U.K. to make the unwinding of its biggest banks less risky for the broader economy.
4. Impose a fee on banks whose size exceeds a certain percentage of GDP to cover the cost they would impose on taxpayers in a bailout, thus eliminating the implicit subsidy of their too-big-to-fail status. 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.
5. In addition, focus on establishing an FDIC insurance premium that better reflects the riskiness of banks’ portfolios. This would provide an incentive for banks to scale down, allowing the financial system to absorb them organically in the event of a collapse.
6. Strengthen capital requirements, moving far beyond what is envisaged in the current Basel Accord. The Accord is a mixture of regulatory oversight and political compromise. As a result, the U.S. has allowed its banking policy to be determined by the “least common denominator” among European and Asian countries, many with a long history of not being prudent.
About the only things not in there are a) a Tobin tax on trading, b) reinstating of Glass Steagall and c) what to do if banks still get in trouble (debt-equity swaps, good bank/bad bank). The stuff on capital requirements is great, and using a bank tax to cut taxes on non-bank firms is quite interesting. (It also avoids the creation of a bailout slush fund that Congress could raid.) Reforming the financial system is low-hanging fruit that Republicans have been reluctant to pick. Huntsman just did.
Elizabeth Warren’s appointment as the effective head of the new Consumer Financial Protection Bureau (CFPB) is all but certain. Last month,