Too Big to Fix

“Looking back, one sees that the crisis was inevitable, if for no other reason than that these too-big-to-fail firms would push the boundaries until there was a crisis.”
 —Thomas Hoenig, Federal Deposit Insurance Corporation director

A strange thing happened to me a couple of years ago. I filled out a direct debit mandate to pay my monthly cell (or mobile, as it’s called here) phone bill. Soon after, a not-insignificant sum of money (that I did not owe) was taken out of my checking account by the mobile phone company.

I rang up the company to inform them of their error, and they advised me to fill out a certain form with my bank. I trustingly attempted to follow this advice only to learn that the form was for seeking reimbursement through my bank’s insurance. Needless to say, the bank had no interest in having their insurance pay for a mistake (or theft) that had nothing to do with them. I went back to the mobile phone company, where I met nothing but resistance—to the point where I had to have a proper row with the fellow I was dealing with. But no matter how much I argued with him, he insisted that there was no way to rectify the error. At one point, he finally burst forth with, “My hands are tied. You Americans have made everything so bloody complicated with your damned Sarbox.”

In the end, I threatened to register a complaint with the Irish Commission for Communications Regulation, and a few days later the money was restored to my bank account, as mysteriously as it had disappeared. To this day, however, I have never figured out exactly what Sarbox (the Sarbanes–Oxley Act of 2002, also known as the Public Company Accounting Reform and Investor Protection Act) had to do with my mobile phone account.

Sarbox imposed all kinds of reporting requirements on American companies and companies wanting to do business in America. It was a reaction to a number of business scandals, notably the collapse of Enron. It had a major impact on the way businesses operate, and it is the reason I always laugh when Democrats try to paint the Bush Administration as some kind of period of massive “deregulation.”

Whatever problems Sarbox was designed to solve, it obviously didn’t work because at the end of the Bush Administration we had a major financial crisis. The solution for this was another major round of regulation, in the form of the Dodd–Frank Wall Street Reform and Consumer Protection Act in 2010. So did that finally fix the country’s financial problems? Does that piece of legislation make another financial crisis less likely?

If you believe that a fundamental problem of the economy is that financial institutions have grown too large, through mergers and acquisitions, only to end up requiring taxpayers to bail them out when they get into trouble because they are Too Big To Fail, then the answer would have to be a resounding no.

An analysis by Hester Peirce and Robert Greene of George Mason University shows that the United States’s bank assets have become even more concentrated in the wake of Sarbox and Dodd-Frank. In 2000 the five largest banks held 30.1 percent of the country’s banking assets, and small banks (those with $10 billion or less in assets) held 27.5 percent. In 2013, the five largest held 46.6 percent and the small banks held 18.6 percent. The small banks’ share of domestic deposits dropped by 9.8 percent just in the period following the passage of Dodd-Frank.

Is this something that would have happened, even without the passage of those two major bills? Almost certainly not, since it is the added cost of complying with government regulations that is driving smaller banks out of business. “The Dodd-Frank Act, passed in 2010, imposes a new set of regulations that are disproportionately burdensome to small banks,” write Peirce and Greene, “Moreover, by designating the largest financial institutions as ‘systemically important,’ Dodd-Frank creates a market expectation that designated firms are too big to fail and generates funding and other competitive advantages for the largest US banks.”

In other words, with Dodd-Frank the government is already laying the groundwork for the next big bailout and, in so doing, is issuing what may be a self-fulfilling prophecy. Having too many assets concentrated in a few large banks makes a financial crisis more likely, as explained in the quote above by FDIC director Thomas Hoenig. When a small bank gets into trouble, it mainly affects the owners of the bank. When a huge bank or a group of huge banks get into trouble, they have an incentive to make things even worse because they know they can get bailed out. If the politicians were truly serious about avoiding another financial crisis, they would be putting limits on the size of banks rather than providing incentives for them to grow even larger.

When you see this happen over and over again, it becomes depressing. It is only a matter of time until the next big business failure ends up hurting employees, shareholders and ultimately the taxpayers who will fund the inevitable bailout. The “solution” will then once again be a major voluminous bill named after another pair of politicians, adding yet another layer of regulations and requirements. Those who favor the bill will be styled as courageous and looking out for the little guy. Those who refuse to go along will be painted as uncaring and in the pocket of fat cats.

Is there any silver lining at all? Well, here’s something. I just heard a rumor that the mobile phone company that tried to rob me might be swallowed up by a larger company.