Better late than never: In the future, in the U.S. too big to fail will be too big

By Money Matters Editors

Perhaps the wind is starting to change in Washington, and logic guided by prudence is starting to prevail.

U.S. Federal Reserve Chairman Ben Bernanke, in a question and answer session after a speech before the Economic Club of New York, said Monday regulators should have the power to shrink or downsize banks that pose risk to the markets.

“The supervisors should be allowed by law to insist that the company divest itself or shrink its activities,” Bernanke said in response to a question.

And to that, Money Matters Editors say, “High time!”

Congress is considering legislation giving the federal government the power to force the break-up of a company that has become so large that its failure in bankruptcy could threaten the U.S. economy. This is legislation that should have been passed decades ago.

Somewhere on the road to efficiency, the United States fell prey to ‘the size monster’ - the notion than a bigger corporation, a bigger bank etc. is always better if the profit metrics indicate such. As it relates to banks, the theory is inherently flawed: bigger is not always better. In fact, it could be worse, particularly if an interruption in a large bank’s operation, say for example Citigroup (C), would jeopardize a substantial portion of the financial transactions in the nation. That structure makes the nation vulnerable to the bank/institution – something that on its face is absurd - and that’s pretty much what occurred during the financial crisis: the federal government, through various agencies, intervened to save both Citibank and the Bank of America (BAC) because it represented the lesser of two evils. Each bank was ‘too big to fail.’ They still are.

But in the future, provided the legislation passes, regulators will have the authority to order the break-up or divestiture if the bank’s misfires could lead to a financial calamity for the nation. In the future, too big to fail will be too big – a policy long that’s overdue, as far as the U.S. taxpayer is concerned.