The Obama administration’s proposal to fund a consumer financial protection agency with fees charged to big banks is smart on two counts: Economically, it helps temper the advantages enjoyed by financial institutions considered too big to fail, thereby discouraging their growth to dangerous levels; and politically, it goes a long way toward securing the support of smaller banks that have staunchly opposed a consumer agency on the grounds that it would further disadvantage them.
The idea is also supremely fair, despite protests to the contrary from the Financial Services Roundtable, which represents large firms. First of all, big banks tend to hold more complicated assets, which make them more expensive to supervise. In addition, numerous academic studies have found that big banks are riskier, more prone to failure, and more expensive for consumers than their smaller counterparts. Their disproportionate contribution to risk should be reflected in the fee structure.
As reported by the Washington Post, the Obama plan would require any bank with more than $10 billion in assets to pay higher fees to its current regulator as well as the new consumer agency. The focus on assets versus deposits is important, because big banks are more likely to hold derivatives and other non-depository assets than smaller banks. The plan would also force non-bank mortgage lenders and other previously unregulated consumer financial firms to pay into the regulatory structure and abide by it. This addresses another source of resentment for small bankers, who have viewed these non-regulated competitors as unfairly advantaged.
The Independent Community Bankers Association, which represents some 8,000 small and mid-sized banks across the country and has a strong lobbying presence, holds a unique, straddling position on financial reform. On one hand, its members favor greater restrictions on big banks and have decried the bailouts, which they view as rewarding risky behavior. At the same time, the group has been courted by big banks to help defeat the proposed financial consumer agency, which both groups have opposed for different reasons.
The Obama funding proposal strikes at the heart of that uneasy alliance, and appears to have been successful. In an Aug. 14 statement, the ICBA hailed the funding plan and asked the administration to strike an even tougher pose toward big banks: “to either downsize these mega-institutions or require them to divest sufficient assets so they no longer pose risks to the entire financial system.” While not specifically addressing the issue of consumer protection, the statement sounded far more conciliatory than in the past, saying: “The ICBA looks forward to working with the Obama administration and Congress on behalf of America’s community banks and the communities they proudly serve to ensure that regulatory reforms make our nation’s financial system even stronger than before the current economic crisis began.”
At a June 10 forum on community banks at the Economic Policy Institute, it became clear that the ICBA shares some positions with progressive reformers and could be an occasional ally with groups such as the broad-based coalition Americans for Financial Reform – but for its intransigence on consumer protection. A break in the old alignments could be good news all around.
From an economic standpoint, the plan is equally deserving of praise. This is the first time the administration has proposed a two-tiered fee structure with a higher penalty on big banks, an approach that could discourage banks from taking advantage of their size or growing very large to begin with. It is too soon to know whether the fees in this package, which have not been announced, are sufficiently large to have such an impact – but they are at least a move in the right direction.
Economists have long worried that banks considered Too Big To Fail enjoy an implicit guarantee from the government and are emboldened to take ever greater risks. The problem, known as moral hazard, was described succinctly by economists John H. Boyd and Ravi Jacannathan in the July issue of The Economists Voice: “Knowing they will be protected by government if things go badly, large banks are willing to take more risk than they otherwise would have done. To make matters worse, the special protection afforded by TBTF status is highly valuable. Recent research suggests that banking firms will pay huge acquisition premiums just to get into the Too Big Too Fail size range.” Boyd and Jacannathan recommend breaking up mega-banks, or at the very least, regulating them much more stringently. The latest Obama proposal would not only do that, it will also ask the big banks to pay for service.
This piece was also published in the Huffington Post