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A Fix For Banks Too Big To Fail: Cut 'Em Down To Size

A branch of Chase bank in New York City. JPMorgan Chase reported $11.7 billion  in earnings in 2009, more than double its revenue from 2008.
A branch of Chase bank in New York City. JPMorgan Chase reported $11.7 billion in earnings in 2009, more than double its revenue from 2008.

As Congress considers new financial regulations, Simon Johnson has some advice that will surely not be taken. But Johnson's advice does possess at least one virtue — you can sum it up in just a few words: If they're too big to fail, make them smaller.

Johnson and James Kwak are the co-authors of a new book, called 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. The book opens on March 27, 2009, in the White House, where President Obama is meeting with the CEOs of some of the largest financial institutions in America. All 13 of these institutions played a role in the financial crisis. Looking back one year later, Johnson says that six of these banks — "The usual suspects; they're the megabanks" — are not just too big to fail; they're too big for the good of the American market.

The six: JPMorgan Chase, Citigroup, Goldman Sachs, Morgan Stanley, Wells Fargo and Bank of America. The danger they pose, Johnson says, is that they're all so huge that if they fall into danger, the government will be forced to bail them out.

"You're going to have a conversation like this with either the Treasury secretary or with the president: Somebody is going to say, 'Let them just fail, just like we did with Lehman,' " Johnson tells NPR's Robert Siegel. "And someone else is going to say, 'Wait a minute. When Lehman went bankrupt that was an enormous disaster. That triggered a global financial panic. We can't do that. We must therefore save them, provide a bailout.' "

But even beyond the government's binding relationship with these enormous institutions, Johnson says that there's simply no virtue in letting a bank grow so huge.

"There is simply no evidence," he says, "for banks over $100 billion in size." Citigroup, Johnson says, was at $2.5 trillion dollars in assets when it ran into trouble in 2008.

"These banks do not benefit society at an additional size but they obviously create big risks for society."

To make the banks smaller, Johnson says the government just needs to "modify and update legislation that already applies to this issue."

"The 1994 Riegle-Neil Act says that no bank can have more than 10 percent of total retail deposits in the country. That's exactly the right kind of idea," Johnson says. "The problem is, since 1994 most of the action in terms of the bank growth has not been in retail deposits; its been in so called wholesale financing. So you want to cap size of banks in terms of their total liabilities and their total assets."

Johnson and Kwak, who also blog about economics at The Baseline Scenario, suggest a cap of 4 percent of the gross domestic product. And that's not even the extreme end of this argument.

"There are some Senate amendments that are pushing towards 3 percent of GDP, and if a bank wants to take on more risk it would have to be substantially smaller. So a Goldman Sachs type of operation would probably be capped around 2 percent of GDP," Johnson says. "These are still big banks. They can operate globally; they can work just fine for the real economy. They will not, of course, generate as much [in] bonuses for the guys who lead them."

The argument that tough capital requirements — that's keeping more money in the bank to protect against risky investments — would solve the problem doesn't float for Johnson. He says that with high enough requirements, that kind of proposal might work. But he's pessimistic that such requirements could be enacted.

He's similarly skeptical of the notion that Washington's actions following the crisis have made another meltdown less likely.

"What we're talking about here is a system of incentives and beliefs in and around Wall Street that leads into big trouble both for the firms involved and for the country. And those incentives and those beliefs have not changed," Johnson says. "The 13 bankers who were brought into the White House last March were basically saved completely. Their bonuses, their people, their staff and their pensions even their boards of directors who'd supervised the most colossal financial collapse you've ever seen, they all stayed in place."

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