The Real Lehman Lesson: Break Up the Banks

Published on AlterNet, by Zach Carter, April 20, 2010.

Tuesday’s hearing on Lehman Brothers’ now infamous Repo 105 scam was only tangentially related to the megabank’s accounting deceptions and subsequent collapse. That story is simple: Lehman almost certainly committed fraud, regulators failed to stop it, and many of the people who screwed up under President George W. Bush inexplicably remain in power under President Barack Obama.

But most of the hearing consisted of Republican members of Congress attempting to paint the failure of Republican regulators as proof that no regulator can ever regulate effectively ever, no matter what. After observers had been subjected to several hours of this argument, former bank regulator William Black took the stand and eviscerated it … 

… Both Fuld and Cruikshank dodged the question. Here’s the real answer: Nothing.

The only way to convince bigwig bankers that their firms are not too-big-to-fail is to break up their companies into smaller institutions that are not too-big-to-fail. Democrats pushing reform want people to believe that a new “resolution mechanism” will solve the problems regulators faced in 2008. Republicans just want to block any reform whatsoever. Congress should establish that new resolution mechanism, but doing so will not end too-big-to-fail.

The FDIC currently has a resolution authority that it uses to shut down failing commercial banks, like Wachovia and Washington Mutual. That authority does not extend to complex bank holding companies that do both commercial banking and other investment banking activities. The FDIC invoked its powers when it shut down Washington Mutual, a $300 billion bank, in September 2008. When Wachovia, a $700 billion bank, found itself on the brink of collapse a few days later, FDIC Chair Sheila Bair wanted to do the same thing.

But the FDIC didn’t shut down Wachovia. Timothy Geithner led a push to skirt the resolution mechanism, and put the government behind a merger between Wachovia and another bank. Geithner won. Even though regulators had the authority to shut down Wachovia and wipe out its shareholders, the government arranged a merger with Wells Fargo that landed Wachovia’s shareholders $15 billion in Wells Fargo stock. A few weeks later, the government kicked Wells $25 billion in TARP funds, another gift to the Wachovia shareholders, who were now Wells Fargo shareholders.

Even though the government had the authority to shut down Wachovia, it chose not to do so, even though the head of the agency with the authority to shut down the bank actually wanted to shut it down. This absurdity will repeat itself the next time any megabank gets into trouble. If we want to protect the economy against Wall Street excess and regulatory failures, breaking up the big banks is the only serious option. (full text).

(Zach Carter is AlterNet’s economics editor. His work has appeared in The Nation, Mother Jones, The American Prospect and Salon).

Links:

Financial Debate Renews Scrutiny on Banks’ Size, by SEWELL CHAN, April 20, 2010.

Goldman Sachs and the Mega Banks: Too Big To Obey The Law, by Simon Johnson, April 20, 2010.

LibDems pledge to break up the banks, by Lee Jones, April 20, 2010.

The Time Has Come to Break Up the Banks, by James Sunshine, April 19, 2010.

break banks on Google videos, April 21, 2010.

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