Here’s a term you may remember from 2008: “too big to fail.” It was the title of a best-selling book and an Emmy-nominated movie, and ultimately the foundation for a collective cultural memory of a time when financial titans sent jobs, homes and taxpayer wealth into the economic afterlife.
It’s the kind of cultural scar you don’t just forget about. But it seems that Hillary Clinton’s banking brain trust is trying to do just that — and rewrite history in the process.
This week, Paul Krugman claimed that “too big to fail was at best marginal” to the crash of 2008. Earlier this month, the economist Austan Goolsbee said on Twitter that “BIG wasn’t what made Bear or Lehman dangerous. it was the ability to spill damage onto others.” Former Rep. Barney Frank (D-Mass.) even said Lehman was “very small” when it failed.
This has accompanied a broader barrage of Clinton rhetoric suggesting that Bernie Sanders’ plan to break up big banks is a weak proposal that ignores her tough-as-nails shadow banking plan. Basically, the argument goes, “too big to fail” was never a serious problem, or at least the “big” part of it wasn’t really a problem, and anyhow, Lehman Brothers wasn’t very big.
Here’s the problem: This is preposterous. In the Obama era, we’ve grown accustomed to evidence-blind nonsense from Republican politicians looking to protect big banks’ profits. But we’ve entered a sad new world when respected liberals start echoing the arguments proffered by Hamilton Place Strategies, a PR shop run by former George W. Bush Treasury spokesman Tony Fratto, who works on behalf of big banks. Krugman, Goolsbee et al. are essentially placing a Democratic Party seal of approval on corporate GOP rhetoric.
The Clinton camp’s “too big to fail” denialism runs against the official conclusion of the Financial Crisis Inquiry Commission, as well as the views of other top finance scholars. Sen. Elizabeth Warren (D-Mass.), former Federal Reserve Chairman Ben Bernanke, former IMF chief economist Simon Johnson, former Federal Deposit Insurance Corp. Chair Sheila Bair, former bank bailout Inspector General Neil Barofsky and FDIC Vice Chairman Thomas Hoenig have all maintained that “too big to fail” was, in fact, central to the crisis.
“I can’t even imagine what he’s talking about,” Barofsky told The Huffington Post, referring to Krugman.
Every official who authorized the bailouts of 2008 and 2009 said they had no choice. They argued that letting big institutions fail would have ravaged the broader economy. The havoc that followed Lehman Brothers’ 2008 bankruptcy demonstrates that this fear was legitimate.
During debates, Clinton has attempted to burnish her “shadow banking” bona fides by citing Lehman Brothers and AIG as shadow banks that would be in her regulatory crosshairs and that Bernie Sanders would supposedly ignore. But Lehman and AIG weren’t simply shadow banks — they were “too big to fail” shadow banks. Breaking them up, as Sanders, Warren and others have called to do, is not a “hands-off” approach, as Gary Gensler, the Clinton campaign’s chief financial officer, has described it.
“Too big to fail” isn’t just a problem of size. It’s a problem of psychology, risk and incentives. If you believe your firm will be rescued by the federal government, you’re going to be more willing to take wildly irresponsible risks. Win, and you’ll get rich; lose, and the taxpayers will save you. A bunch of banks made that bet all the way through the 2008 crash. Indeed, Lehman Brothers’ refusal to accept private-sector rescue financing in 2008 was predicated on its executives’ conviction that the government would never let them go under.
The same logic applies to the creditors of a “too big to fail” bank. Why worry about lending money to these guys if you’re going to get paid in full by the government?
“Size does matter, but that’s not really all that the reimplementation of Glass-Steagall or any other limit on bank size would do,” said former Rep. Brad Miller (D-N.C.), who authored the mortgage lending rules in Dodd-Frank, the landmark financial regulatory bill passed in 2010. “It would also reduce the liquidity that causes a complete loss of market discipline because lenders figure that their borrower will be rescued if they can’t pay back their loan.”
This doesn’t mean there aren’t good reasons to place new regulations on the markets where banks and other financial firms were taking ill-advised risks. But those markets wouldn’t have been such cesspools in the first place without the “too big to fail” incentives that encouraged big banks to pollute them.
We should also dispense with the idea that Clinton’s own shadow banking proposals — while perfectly sensible — are somehow uniquely tough or comprehensive. Krugman, Matt Yglesias, Ezra Klein and Mike Konczal have all heralded her plan, but they’ve glossed over the fact that many of Clinton’s shadow banking proposals are already being pursued by federal regulators (there’s a list of these at the bottom of the article). They’re also ignoring a major item in Warren’s Glass-Steagall bill that Sanders has endorsed.
That bill would repeal some major perks Congress afforded to shadow banking in 2005, allowing anybody involved in a repurchase agreement — “repo” in Wall Street lingo — to get paid back before a bankrupt firm enters bankruptcy court. That provided a major incentive to firms to keep lending money to banks taking huge risks, even after it became clear that the banks were in trouble.
“The Warren bill would be a very dramatic change in repo lending and shadow banking more generally,” Miller said. “Sanders has not been given much credit for that, but it is a much more substantive plan than anything that Clinton has put forward.”
Clinton’s banking backers are thus not calling for tougher regulation. Rather, they’re defending the regulatory status quo, while slamming Sanders for attempting to take stronger measures. In doing so, they’re peddling a myth about how the financial crisis happened — namely, that risks magically materialized in the shadow banking ether without the participation of actual shadow banks. Or, as Bair put it to HuffPost, “For heaven’s sake, who was doing the repos?”
There’s a reason why new, stronger capital rules for big banks were among the first actions taken by federal regulators after the crisis. Forcing banks to carry more capital limits their ability to take risks anywhere in the financial system — including the shadow banking markets. The arguments Krugman, Goolsbee et al. have presented against breaking up banks apply just as strongly against imposing tougher capital standards. If the real problem was an amorphous, dematerialized “shadow banking,” there’d be no need to make such a fuss about capital.
Krugman, Hamilton Place and others have previously noted that the absence of big banks didn’t prevent the Great Depression. They’re right. But bank failures alone didn’t cause the Depression. The Federal Reserve was operating on the gold standard, which caused it to restrict the money supply — making the crisis much, much worse than it needed to be. And the widespread rash of bank failures was spurred on by the lack of federal deposit insurance, which encouraged bank runs as worried citizens rushed to get their money out. Just because “too big to fail” didn’t cause the Great Depression doesn’t mean it wouldn’t have made it much worse.
“Everyone, including the administration, agrees that ‘too big to fail’ was a problem/policy issue to deal with by early 2009,” Johnson told HuffPost in an email.
“Did Dodd-Frank completely and entirely ‘fix’ the problem of ‘too big to fail?'” he went on. “I don’t know anyone in the policy arena who thinks that it did.”
Breaking up big banks isn’t going to prevent every potential weird buildup of risk in the financial system. But it would dramatically limit the severity of whatever happens in the next crisis, and could indeed stop certain crises before they start.
It’s one thing to shrug off Sanders’ plans in the name of electability. It’s quite another to rewrite history for the same reason. It’s going to be very difficult for either Clinton or Sanders to implement new proposals with a GOP Congress. But there will, at some point, be another financial crisis, and the public will demand a response. If the Democratic Party has deliberately unlearned the lessons of 2008, it won’t have the right answer.
Here’s a list of Clinton’s shadow banking proposals that are already in the regulatory pipeline:
- Create a new “risk fee” on big banks that would “discourage large financial institutions from relying on excessive leverage and the kinds of ‘hot’ short-term money that proved particularly damaging during the crisis.” The Federal Reserve requires big banks that are reliant on short-term debt to stump up more capital than their peers.
- “Impose, in coordination with other major international financial centers, margin and collateral requirements on repurchase agreements and other securities financing transactions.” The Federal Reserve is doing this now.
- “Enhance public disclosure requirements for repurchase agreements, so that both regulators and market participants can more fully understand the risks associated with these activities.” The Federal Reserve Bank of New York regularly publishes data on repurchase agreements. U.S. regulators recently published the results of a pilot program that collected vast amounts of data on repurchase agreements, and are now working with international regulators to cover the entire market, making it permanent and global.
- “Strengthen leverage restrictions and liquidity requirements for broker-dealers, which played a key role in the recent crisis.” The Securities and Exchange Commission has repeatedly said this is under consideration.
- “Enhance regulatory reporting requirements for hedge funds and private equity firms.” The SEC already requires private funds to regularly detail their holdings in a document called Form PF. Researchers at the federal Office of Financial Research said in a paper last year that the submissions “may obscure reporting funds’ actual risks” — a potential problem that regulators themselves can fix. The SEC, for example, updated the form in 2014 to require more information.
- “Create compensation rules to curb behavior that puts our financial system at risk.” Federal regulators have proposed rules that seek to achieve exactly what Clinton is aiming for. The rules have not been finalized.
- “Enhance international cooperation to curb excessive risk-taking” by “fight[ing] for stronger global capital requirements and tougher margin and collateral requirements for securities financing and derivatives transactions.” U.S. regulators are already leading the way when it comes to tougher requirements for financial firms in order to reduce the risk they or their activities pose to the U.S. economy. Their efforts have been referred to as “gold-plating.”
- “Bolster the financial system’s defenses against the threat of cyber attacks” by “encourag[ing] regulators to consider cyber-preparedness as a significant part of their assessments of financial institutions.” The Office of the Comptroller of the Currency, a federal bank regulator, said in June it plans to do this.