It’s tough to imagine a big bank but maybe the following Mother Jones graphic (2009) can help out.
By 2008, the four major banks–Citigroup JPMorgan Chase, Bank of America, Wells Fargo–had acquired 35 businesses that had been independent in 1990. Having become so large that their “distress” could threaten the entire U.S. financial system, those four banks became “too big to fail.”
Where are we going? To the regulatory dilemmas that large financial institutions create.
A Too Big To Fail Tale
Our story starts in 1980 with a little and a big bank. Penn Square was a “shopping center bank” in Oklahoma while Continental Illinois National Bank and Trust was among the largest in the country. The Penn Squares of the world were one reason Continental was so big. Because Continental was prohibited from having out-of-state branches, it did all of its non-Illinois business with long distance deals. Through those deals in Oklahoma, it supported risky oil and gas ventures.
By 1982 Penn Square had failed, other questionable loans and relationships began to fall apart, and Continental became the target of rumors that eventually led to a run on the bank. And here is where too big to fail enters the picture. With withdrawals multiplying and the bank’s corporate relationships evaporating, regulators had a dilemma, On the one hand, if they let the bank fail, the U.S. economy could suffer. On the other, a bailout would set a precedent through which government prevented the market from punishing foolhardy risk taking.
They chose the bailout.
Our Bottom Line: Too Big To Fail
We could say that the pendulum of banking regulation has swung back and forth. Following more than a decade of risky banking behavior, Glass Steagall (1933) increased regulatory oversight and diminished banks’ ability compete.
But by the 1970s, it all reversed. Called disintermediation, the banks were so uncompetitive that depositors were leaving for more attractive deals. The response was de-regulation, more competition, the return of risky banking behavior and new concern about too big to fail.
And now again with Dodd Frank, we have moved to the regulatory side but this week’s Met Life news could swing us the other way.
To understand this problem, you almost need to go back to the garden of Eden. The “bite of the apple” that got it rolling was the creation of deposit insurance.
Deposit insurance allowed banks using unsound lending practices to access nearly unlimited funding, because depositors were effectively insulated from this risk.
Before deposit insurance, you had bank runs, but depositors were a LOT more choosy when selecting a place to put savings.
Not sure it is possible to turn back the clock, but that is the “rest of the story”.
No we cannot turn back the clock. But interesting to contemplate.