The Largest U.S. Banks Remain Too-Big-to-Fail
The largest U.S. banks remain Too-Big-to-Fail (TBTF). Their structure is thoroughly “socialist.” Political rhetoric in some circles seems to define “socialism” as any involvement of the government and the taxpayer in citizens’ lives. The U.S. banking structure is socialism for the richest. It also exacerbates the widening of income inequality.
Investment banking and its unique risks were merged into commercial banking — not only with its risks, but, more importantly, with its FDIC deposit GUARANTEE. That’s a U.S. taxpayer-backed deposit insurance system. The merger began in the Reagan administration, was finalized in the Clinton administration, and was protected in subsequent administrations. The big banks’ cultures are now dominated by their investment banking activities, not those of their commercial bank.
When the subprime mortgage/derivatives bubble burst in 2008, many well-known and highly regarded financial executives including CEOs publicly called for a return to the separation of commercial and investment banking. Instead, the largest banks made sure all the nation got was the Dodd-Frank legislation that strengthened the government’s legal ability to bail out large financial institutions and smothered the industry in layers of regulation.
The data still trumpets that the TBTF banks are Too Big To Fail. They are not only massive, measured by assets, but also thoroughly tied together through derivatives. If one goes down, they all collapse. The link to the ranking of the top banks follows. The top six are far larger by assets than the rest of the industry. [Here’s the link. It looks bold in my WordPress draft, but doesn’t publish bold. Telling you this is easier than me, at 73, figuring out how to get into the programming.]
https://www.ffiec.gov/npw/Institution/TopHoldings
Derivatives Tie Them Together
Derivatives remain a major business activity for the biggest banks. The Office of the Comptroller of the Currency publishes a quarterly report thoroughly describing derivatives activities among U.S. banks. A link to the report is below. The report shows that the largest still sell credit insurance, called credit default swaps. (There is no “swap” involved in my home or car insurance, nor in these contracts.)
Most derivatives these days are booked in the FDIC-guaranteed bank subsidiary. That wasn’t always the case. The reason for the change is to protect derivatives counterparties, the two parties to a derivatives contract. The data in the following link illustrates that booking fact, using the OCC derivatives report, Tables 13 and 14 on pages 17 and 18. I periodically updated the calculations since 1998. An earlier chart in the second link (through 2019) shows how the biggest banks’ derivatives are held mainly for trading.
DerivativesPercentinFDICGuaranteedBankvsHC
PeerReportDerivsasPercentAssetsThru2019MultiYrHistory
Note these observations. JPMorgan, with its “fortress balance sheet” has always booked its derivatives in its FDIC-guaranteed bank. Citigroup first booked about half in its FDIC-guaranteed Citibank, then moved more until nearly all were there when the bubble burst. Goldman Sachs was an investment bank with a tiny Utah-chartered “industrial bank,” Goldman Sachs Bank USA, until the bubble burst. Their charter moved to New York, bringing Goldman into “bank holding company” regulatory oversight of the Federal Reserve. Morgan Stanley has always had a small, but real FDIC-guaranteed bank to support its money management business segment which serves retail investors.
The FDIC itself was against this move during the 2008 crisis. An October 18, 2011, Bloomberg News article alerted me to the dispute. The title and initial sentences summarize the gist of the article. Bank of America was acquiring Merrill Lynch to rescue it from pending failure (at that time, certainly not now). The Federal Reserve had allowed Bank of America to move Merrill Lynch’s derivatives from a non-bank subsidiary into the FDIC-guaranteed bank, Bank of America, N.A. The FDIC did not support this move, but was overruled by the Fed. The Fed’s pure pragmatism– trying to keep the big behemoths afloat — was clashing with the FDIC’s defense of taxpayer interests. It also put the interests of derivatives counterparties and the biggest banks, which trade derivatives, well ahead of the interests of the taxpayers who back the FDIC’s guarantee of bank deposits.
When these TBTF banks fail, they all fail together and the taxpayer is on the hook. Again. Why this is the case is described in the blog post “Reason #5: TBTF Banks Are Tied Together Through Derivatives.” (Here’s a LINK to that post. http://www.fairytalecapitalist.com/break-em-reason-5-tbtf-banks-tied-together-derivatives/
While some material improvements in industry risk management have been instituted, the Federal Deposit Insurance Corporation’s rescue of Silicon Valley Bank revealed the widening of taxpayer-backed insurance to the high-risk venture capital sector. Silicon Valley Bank’s 10-K, the annual report to the Securities and Exchange Commission, described how it focused on that industry sector. The next link is to the first 37 pages of SVB’s 10-K of 2021. The 10-K is the official annual report required by the Securities and Exchange Commission (SEC). The 10-K must provide vast detail in a prescribed format. After the report’s index, it launches into a description of its business and the risks it faces.
This “rescue” leads to several questions. Why doesn’t the FDIC require a much higher insurance premium for deposit insurance for bankers concentrating on very high-risk businesses than for banks serving a broad slice of the economy? Why protect every deposit if the FDIC deposit guarantee is for a maximum of $250,000? What is the purpose of that maximum? (There’s a very interesting history about that issue, linked at the end of this post.) The maximum started at $2,500 in 1933 when the FDIC was legislated into existence. In recent decades, the maximum was dramatically increased after major financial crises. Inflation-adjusted, the $2,500 would be $58,900 in 2023 dollars per the Minneapolis Fed’s inflation calculator. The actual maximum, set after the 2008 crisis, is currently $250,000.
Socialism — If That’s How You Define It
Describing the structure of our biggest banks as “socialist” is just trying make a point. In fact, I am referencing one I heard in my Christian upbringing. Jesus said, “Why do you see the speck in your brother’s eye, but do not notice the log that is in your own eye?” [Matthew 7:3] If a public figure uses “socialism” to describe government programs that aid the poor or the middle class, they should use the same term for the government programs that aid the truly wealthy.
Any attempts to address this structural issue, as with the top three financial issues which are the focus of this blog, cannot happen quickly. I am not so naive to believe that investment banking is going to be separated from commercial banking any time soon. The 2008 crisis might have been a lost opportunity, and one doesn’t wish for another banking crisis. But please quit calling government programs “socialism.” The nation is certainly out of balance on spending and debt among many things, but a divisive label isn’t constructive debate. Also, for Wall Street and perhaps others, QUIT COMPLAINING ABOUT THE REGULATORY BURDEN. If you don’t like it, propose how YOU would “break them up.”
Here Are the Two Good Reads on FDIC History
https://www.fdic.gov/bank/historical/firstfifty/chapter4.pdf
And a Little Dodd-Frank History
[There’s a link to Greenberger’s testimony if it isn’t obvious from the way this post is published. Look for the word “testified” in italics.]
On June 30th, 2010, in Congress’s first Financial Crisis Inquiry Commission hearing, Professor Michael Greenberger of the University of Maryland School of Law testified that $52 trillion in derivatives risk was at stake at the time of the meltdown, an amount nearly the size of the entire world’s GDP — measured using the Fed’s assumptions, but conservatively measured in his opinion. He emphasized the point that “The Taxpayer is the Lender of Last Resort in the CDS Casino” and described the interconnectedness of the other types of over-the-counter derivatives that actually create “Too Big to Fail.” He referenced former regulators who shared his opinion. Congress didn’t take any time to understand derivatives when passing Dodd-Frank. It was passed just days later, totally ignoring this testimony.
Other Key Posts in This Category
The 2010 Dodd-Frank Act purported to overhaul financial regulation in the aftermath of the collapse of the subprime mortgage/derivatives bubble. The massive government bailout that followed the near collapse of the biggest banks has been named The Great Recession. It would have been another Great Depression had the government not bailed out the banks. But instead of minimizing the chances of another bubble being built through the risk-taking of these Wall Street giants backed by the U.S. taxpayer, Dodd-Frank just made it easier to bail them out by strengthening the government’s legal ability to do so. No wonder the biggest banks and so many politicians supported Dodd-Frank.
http://www.fairytalecapitalist.com/dodd-franks-resolution-authority-not-little-just-late/
Here’s the post on how the politicians were paid to support the biggest banks. Money in those politics, leading up to Dodd-Frank.
http://www.fairytalecapitalist.com/break-em-money-politics-challenges-real-solution-systemic-risk/
Building Too-Big-to-Fail banks didn’t happen overnight. It started with the Reagan administration and proceeded through them all. Right up to their near collapse, the passage of Dodd-Frank, and beyond — right through Silicon Valley Bank, as I describe in the above post.
http://www.fairytalecapitalist.com/break-em-creating-systemic-tbtf-banks/
I still stand by my argument first published in my book in 2010. Putting the U.S. taxpayer (in the commercial banks with their FDIC deposit guarantee) behind investment banking’s trading risks and then tying those biggest banks together like a series of idiot mittens through derivatives is what led to the creation of the massive real estate/subprime mortgage/derivatives bubble that unraveled in 2007-2008. No need to buy my book. The argument is here. I don’t want fame or money. I’m a rather private person. I just want to advocate for real democracy and real capitalism to defend this imperfect bottoms-up form of government for our children. This is my small, unsilenced, unsensored voice. Please use yours to talk to others. I hope I’ve provided an example of constructive dialog.
http://www.fairytalecapitalist.com/break-em-ten-reasons-isolate-taxpayers-tbtf-systemic-banks/
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