New Financial Reform Bill Would Slash Big Banks in Half

As Republicans inch closer to Democrats on the piece of financial reform that would limit and regulate the trading of complex instruments called derivatives, some Democratic are trotting out increasingly aggressive strategies to break up the big banks.

Sen. Chuck Schumer is building bipartisan support to levy a bank tax similar to the 0.15 percent profits-tax that Obama floated in January to pay down TARP. Meanwhile four Democratic senators have proposed an even stronger shrink-the-banks bill that would cap leverage at 16:1 and enact two more hard ceilings on deposits and liabilities. Those plans are:

1) Cap at 10% a bank's share of total US deposits.

Would that accomplish much? In mid-2009 the largest commercial bank in the US, Bank of America, had 12% of total US deposits, and it has been considered too big to fail. Shrinking it to 10% won't it's TBTF status dramatically. No other bank held more than 10 percent of total domestic deposits. Anyway, deposits aren't the central problem. Liabilities are what crater a firm when the market turns down. A more direct way to get at this problem would be capital requirements or leverage caps to limit risk-taking. So here we go...

2) Reduce the max amount of non-deposit liabilities to 2% of US GDP for banks, and 3% of GDP for non-bank institutions.

Now this is the blunt instrument. Bank of America, Citigroup, Goldman Sachs, JP Morgan Chase and Morgan Stanley all now have non-deposit liabilities in the neighborhood of 5-8 percent of GDP, according to this column from New Rules. In short, this rule would require all of these organizations to effectively split into at least two pieces.

Obama likes to approach fundamental change by chiseling away at bad incentives. This bill approaches fundamental change by taking a sledgehammer to Wall St. And that's exactly why we should expect this law -- which Tim Fernholz writes might appear as an amendment to the Senate reform bill -- will either go nowhere fast or re-inspire the fury of Republicans who seem to be edging toward a kumbaya on financial reform. If Democrats want to fight, this bill will make for a good ammunition. If they want a bill, and soon, it will make for good recycling paper.