WORRYING ABOUT THE AFTERLIFE OF BANKS THAT FAIL
Bank of America (BAC) and Citigroup (C) stood out for all the wrong reasons in the Aug. 8 market decline. Shares of the two banks—both are among the roughly 40 U.S. institutions considered too big to fail—led the 634-point drop amid new doubts about the quality of the assets buried on their balance sheets. Investors now believe Bank of America’s net worth is only about a third of what the bank claims; for Citigroup the figure is less than half.
Dodd-Frank, adopted in response to the financial convulsions of 2008, required banks to draw up so-called living wills, which describe how a failing bank could wind down its business and avoid dragging down other companies. In theory, this should mean a bank would sell pieces of its business, place others into bankruptcy, and close remaining operations. But regulators have put a deadline for writing living will guidelines on hold while they coordinate with overseas regulators. Former Federal Deposit Insurance Corp. Chairman Sheila C. Bair wanted the rules for drafting living wills in place by the end of August. That seems appropriate.
Dodd-Frank also required that regulators set up an orderly resolution authority. This authority, established in July 2010, in combination with living wills, would provide a controlled setting for disassembling a large bank. The authority, among other things, lets the FDIC use its money to pay creditors or counterparties of a failing bank so that they, too, don’t collapse in a chain reaction.
In reality, no one knows how any of this would work with companies as vast as Bank of America and Citigroup. Even when markets are stable, the list of potential buyers for Bank of America’s $2 trillion in assets—or any other major bank’s—is short. It would be shorter still in times of crisis, when bank failures tend to occur.
All the more reason regulators also need to push back against the banking industry’s entreaties not to increase capital requirements too much. Big banks eventually may be required to hold capital equal to as much as 10 percent of assets. When it comes to bank capital, more is almost always better; the 10 percent level now under discussion at the Federal Reserve probably isn’t high enough.
Speculation that Bank of America will raise capital is certainly among the reasons the shares have plunged. Investors are worried that new stock will be sold, diluting their existing holdings. They may have to take their lumps, but if fresh capital is needed there may be no alternative.
One more thing federal regulators should do: maintain a hard stand against any increases in dividends by weak banks for the foreseeable future. Dividends drain money that can be used to shore up capital and make a bank sounder. At a time when some pundits are declaring the too-big-to-fail problem unresolved, it behooves regulators to do what they can to prove them wrong.
A NO-TAX STAND, BASED ON NO FACTS
You would think that abysmal growth and jobs data, the first-ever downgrade of U.S. debt, and heart-stopping gyrations in the financial markets would impel political leaders at least to take a second look at some of their assumptions about restoring confidence in the U.S. economy. Sadly, you would be mistaken.
Whatever one thinks of the validity of Standard & Poor’s (MHP) decision to downgrade U.S. debt, it contained an admonition that we should take seriously: Spending cuts alone won’t place the debt, and by extension the economy, on a sustainable path. In a memo to his Republican colleagues, House Majority Leader Eric Cantor warned that S&P’s analysis put the party under “pressure to compromise on tax increases” on the ground that there is “no other way forward.” His response: “I respectfully disagree.”
As always, the Republican leaders justified their intransigence by invoking the demons of job-killing taxes that would suppress the dynamism of overtaxed Americans, hampering growth. This is partisan nonsense. In terms of the economy as a whole, federal taxes are at their lowest level since 1950. The Congressional Budget Office estimated that federal taxes would account for 14.8 percent of gross domestic product in 2011.
That isn’t a one-year anomaly: Revenue was 14.9 percent of GDP in both 2009 and 2010. Compare that with a postwar average of about 18.5 percent of GDP, and an average of 18.2 percent during the Administration of President Ronald Reagan. Which brings us to another dubious claim: Raising taxes in a downturn hinders growth. In 1982, amid a punishing 16-month recession, Reagan approved the largest peacetime tax increase in U.S. history. A booming economy followed in 1983 and 1984, enabling him to sail to re-election.
In 1993, President Bill Clinton forced a tax increase through Congress that Representative Dick Armey, then chairman of the House Republican Conference, condemned as a “job killer” that would push the economy into recession. That increase was succeeded by the creation of 23 million new jobs, and the Clinton Administration left a budget surplus of about $236 billion. By contrast, President George W. Bush pushed through two rounds of tax cuts and created just 3 million jobs. He also turned the surplus he inherited into a $1.2 trillion deficit.
Obviously, today’s economic crisis is vastly more severe than anything Reagan or Clinton faced, thus the timing and scope of tax increases must be carefully calibrated. Over the long term, however, the Republican mantra of “no higher taxes, ever” is as senseless as are claims by some Democrats that we can solve our fiscal gaps simply by soaking the rich. Both spending cuts and revenue increases are required.