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Monday, May 23, 2011

Too Big to Fail: The Trillion Dollar Club

Banks with assets over $50 billion are considered “systemically important” according to the Dodd-Frank law of 2010. The act is geared to shoring up protection against systemic risk. The U.S. Goverment deems certain banks (and companies) systemically important if they are big enough to threaten the entire financial system should they fail. Such enterprises are subject to higher capital standards and stricter rules. Roughly three dozen banks in the U.S. had been classified as systemically important by mid-May 2011.

A major flaw in the law is its failure to sufficiently distinguish the banks having assets at just over $50 billion (the floor of systemically important) from the banks with assets over $1 trillion. For example, Bank of America ($2.28 trillion), J.P. Morgan Chase ($2.2 trillion), Citigroup ($1.95 trillion), and Wells Fargo ($1.24 trillion) can be clustered and distinguished from Huntington Bancshares ($52.95 billion), CIT Group ($50.85 billion), Zions Bancorp ($50.81 billion), and Marshall & Ilsley ($49.68 billion). If just one of the institutions in the over $1 trillion club fails, the financial system worldwide could be toast. In contrast, the system would be more likely to remain viable if just one of the banks with assets of around $50 billion were to fail.

Of the $50 billion club, Stephen Steinour, chair and CEO of Huntington, stresses, “We are not vital to the economic system of the U.S.” The chair and CEO of Bank of America could not make the same claim. However, Steinour is ignoring the possibility that Huntington could be a domino in a line of similar banks whose failures altogether could challenge the viability of the financial system; yet even this risk can and should be distinguished from the inherent systemic risk in just one of the banks in the $1 trillion plus club.  Furthermore, those big banks have grown even larger since before the financial crisis—meaning that their systemic risk is higher rather than lower after the crisis. At the end of 2010, the top ten banks in U.S. had 77% of the banking assets in the U.S.

In 2007, Bank of America had assets of $1.54 trillion; by 2011 that number had moved to $2.28 trillion. J.P. Morgan Chase had gone from $1.46 trillion to $2.20 trillion, and Wells Fargo went from $539 billion to $1.24 trillion. Citigroup bucks this trend, moving from $2.22 trillion down to $1.95 trillion. Generally speaking, this cluster of banks represents more rather than less systemic risk after the crisis of 2008.  Were one of these banks to founder, a government-arranged orderly liquidation as per the Dodd-Frank law might not be sufficient to keep credit markets from freezing up. The very existence of a bank with more than $1 trillion in assets should be questioned. Ironically, efforts to evade financial catastrophe in the fall of 2008 contributed to the increase in size. That is to say, staving off the crisis may have made another more likely in the future.

So especially after the scare in 2008, it is incumbant on us to question the sheer existence of the banks that have been allowed and in fact encouraged to get bigger. If a bank having more than $1 trillion in assets is deemed necessary for corporate capitalism to function in spite of such a bank's inherent systemic risk, one might ask how the system got along without them before they had grown so big. After all, it is not unheard of for a syndicate of banks to package financing on a mega-LBO (leveraged buy-out); one mega-bank is not necessary. Indeed, mega-LBOs themselves may result in unacceptable systemic risk. Finance itself, and particularly the increasing role of leverage, can also be subjected to question. 

Although distasteful from the vantage-point of the financial interests vested in the status quo, the trillion-dollar-plus club of banks could be treated differently than the banks of around $50 billion. Whereas the latter could be more strictly regulated, the former could be broken up not only in terms of management, but also in ownership (rather than the spin-offs having the same fractional owners, as was the case with Standard Oil after its “break-up”).  Considering that obviating financial collapse in 2008 included the byproduct of even larger banks, a second systemic-risk law delimiting a maximum size could complement existing anti-trust laws. Unfortunately, the Dodd-Frank law does not address this point, and is thus insufficient from the standpoint of obviating the systemic risk of firms being too big to fail.


Robin Sidel and Jean Eaglesham, “Vital? Not Us, Say Small Banks,” The Wall Street Journal, May 13, 2011, p. C1.

2007 Bank Assets, ForbesAdvice.com.