Does the Senate's Bank Bill Solve Too Big to Fail?

Financial reform has passed the Senate. The question for a lot of people out there will be: Does this bill solve "Too Big to Fail," the idea that banks can get so big and interconnected that they can make dangerous bets and enjoy an advantage over smaller banks because everybody expects the government to backstop serious losses.

So does this bill solve "Too Big to Fail"? Eh.

The sharpest arrow in Dodd's quiver is the liquidation authority measure. The idea is that we design an orderly process to wind down failing financial institutions through the FDIC rather than save them. Proponents say this changes the calculus of betting big. Opponents counter that in another financial catastrophe, we can't "orderly liquify" multiple banks with trillions of dollars in assets. So we'll bail them out for the sake of the economy, and RIP TBTF.

The liquidation authority is an implicit effort to kill TBTF. It discourages, but it does not mandate. More explicit would be requirements that the banks be smaller. You could do this through capital requirements, or leverage limits, which would slim down balance sheets. Or you could tax bank size, the sheer weight of assets, or tax certain types of investments, or even levy taxes on financial institutions when the market perceives them to be at risk of default. None of those ideas are in the Senate bill that passed last night.

But Noam Scheiber has an interesting take on the smaller mandates and regulations that together increase the cost of being big.

And yet, perhaps unwittingly, the upshot of financial reform will have been to make it costlier to be a big bank relative to being a small or medium-sized bank--which is to say, it has effectively taxed bigness. That's because the legislation imposes a handful of new mandates and regulations--like oversight by a soon-to-be-established consumer financial protection agency, as well as limits on fees for debit-card transactions--from which small and medium-sized banks are exempt. Other reforms--such as a bill Congress passed last year to limit hidden credit-card fees and make statements more transparent, and new restrictions on trading derivatives--would disproportionately dent profits at megabanks. These banks tend to have far bigger credit card operations, and are the only bona fide derivatives dealers around.

The big banks typically complain that these efforts will drive them out of this or that line of business, or at least curtail their activity significantly. And there may be something to those concerns. But in a world in which we worry about megabanks doing too much rather than too little, that's not necessarily a bad thing. If only there were a bit more of it.