The Republican presidential hopeful suggests ways to fix the too big to fail problem... with Democrats' ideas
If only former Utah governor and GOP presidential hopeful Jon Huntsman had been a Republican senator in 2010, he might have helped to ensure that the Dodd-Frank financial regulation bill passed on schedule. In an op-ed in today's Wall Street Journal, he argues that too big to fail is still a problem. He's right. But his solutions aren't likely to make much difference: most are already contained in the very regulation bill he assails.
A Good Start
Huntsman starts off by naming some deficiencies in the Dodd-Frank bill:
- Fannie and Freddie, recipients of a huge bailout and key causes of the housing bubble, go completely unaddressed
- The Fed's easy money policies weren't reigned in
- The ratings industry wasn't significantly reformed
- Regulatory capture by banks can still occur
These are all valid criticisms. But when he begins to provide his solutions to the too big to fail problem, it becomes clear that he probably hasn't actually read the Dodd-Frank bill. If he does, he might like it more than he realizes.
No More Bailouts!
He asserts that there is no evidence that very large institutions "add sufficient value to offset the systemic risk they pose." That may be true. Others might argue that the size of banks weren't the problem but that the interconnected nature of the modern financial industry makes it susceptible to crises anytime too much correlated risk builds up in the system. But if Huntsman identifies with the big-banks-are-bad camp, shouldn't it follow that they must be broken up?
Apparently not. Instead, he starts:
The best would be to eliminate Dodd-Frank's backstop.
I'm not sure what he means by "Dodd-Frank's backstop," because the bill provides no explicit backstop. In fact, it tries very hard to ensure that there won't be future bailouts, revoking the Fed's ability to rescue specific institutions. But the next thing he says is even more perplexing:
Congress should explore reforms now being considered by the U.K. to make the unwinding of its biggest banks less risky for the broader economy.
Oh, you mean like maybe a new mechanism that allows regulators to seize giant failing institutions and follow living wills that they had produced to wind them down as quickly and cleanly as possible? That's a great idea: and you can call it the "orderly liquidation authority." That name has a nice ring to it, since that's what the Dodd Frank bill called precisely this new mechanism it created through its second title.
Tax the Big Banks
But maybe this isn't what Huntsman means. He continues by suggesting that big banks should be forced to endure higher regulatory costs. He thinks this will encourage them to downsize. Maybe, but size provides significant competitive benefits to banks, which could exceed modestly higher regulatory costs. He suggests imposing a fee on these banks if they get too large. That money, he says, could be used to pay back taxpayers if they have to be bailed out. (I know, I thought he was against this too, but let's allow this slide.)
If you followed the financial regulation battle least year, then this proposal should sound familiar. Late versions of the bill included precisely such a provision -- it called for a tax on large institutions to create a $50 billion fund to pay for future bailouts. Republicans were against it, because it implied that bailouts would occur in the future, which nobody was willing to admit.
So the concept evolved. The version of the legislation that Democrats thought was final included a $19 billion tax on large banks and hedge funds to pay for the bill's costs. But in that form, the bill couldn't get through the Senate. The moderate Republican Senators who had agreed to vote for the legislation to avoid filibuster didn't realize that this tax-like provision was in there. So they balked, and Democrats were forced to drop the provision.
In other words, Huntsman here is arguing for something that not even centrist Republicans supported.
In practice, Dodd-Frank actually sort of accomplishes the end that Huntsman seeks through another means. It tells the financial stability council to force big banks to endure higher capital requirements than smaller banks. This change will go into effect once the Basel III capital requirements are adopted. And the big banks aren't pleased.
But Huntsman does offer one good idea that didn't get much airtime throughout the financial regulation battle:
Congress could also implement tax reform that eliminates the deduction for interest payments that gives a preference to debt over equity, thus ending subsidies for excess leverage.
Absolutely. Yes. Let's do it. Leverage was a big problem. The higher capital requirements that Basel III will bring ought to help here a little. However, banks like leverage for reasons other than just the tax advantage: if you can borrow for cheaper than the return you can achieve on that borrowed capital, then you can make lots of money. And the more borrowing you do, the higher your return on capital. So this proposal, while a good idea, might not have a huge impact.
You know what would be more effective? An actual limit to leverage. And you won't guess who thought of that: that's right, the Democrats who crafted Dodd-Frank. It requires that big banks ($50 billion or more in assets) maintain a leverage ratio of no greater than 15 to 1. So in a sense, calling for less leverage is another inadvertent nod to Dodd-Frank, though Huntsman does offer another sensible way to discourage excessive borrowing.
Some of Huntsman's ideas here aren't that off base. He just doesn't appear to realize that many of them have already been made law by Dodd-Frank. On some level, it's hard to fault him. Almost nobody outside the financial industry paid much attention to the regulation battle last summer. But if he wants to take on a complex issue like financial stability, he needs to do his homework.
Image Credit: REUTERS/Yuri Gripas