Big Fines Won't Solve Too Big to Fail

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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Five years after the financial crisis, the "too big to fail" banks have paid $100 billion in legal costs -- which are still mounting. That's the finding of a new Bloomberg investigation that added up not just the cost of lawyers, but also settlements over the banks' mortgage practices and other offenses against common sense. The sum is more than their combined profits last year, and more than they have paid out in dividends since the financial crisis.

And there's probably more to come. Firms like JPMorgan Chase & Co. are still the focus of government probes, and U.S. Attorney General Eric Holder has been making noises about bringing some crisis-related prosecutions (though he declined to name which firms he'd be prosecuting). With the statute of limitations on many white-collar crimes close to expiring, Holder is presumably under some pressure to bring even weak cases to court, rather than lose the chance entirely.

Is this enough to deter a repeat of the financial crisis? Unlikely -- but mostly because I don't think that the financial crisis could have been deterred by punishing the big banks. They did some incredibly stupid and possibly unscrupulous things, but this only became a crisis because of all the other people doing incredibly stupid and possibly unscrupulous things. Every dodgy "liar loan" they packaged into a shoddy mortgage security started with a dodgy liar living in a house he couldn't afford. Even the people on the other side of the trade may not have wanted to know too much about the quality of the loans in those securities.

My general theory of the financial crisis was that it was a sort of folie-a-300 million, with the envelope being pushed in every direction by millions of people who thought they'd discovered a free money tree in the backyard of every middlebrow McMansion and sad-sack split-level in America. If all these people had thought the financial crisis -- or even just a bad housing crash -- was coming, they'd have acted differently. But they didn't, so they didn't.

Mostly this will depress shareholder earnings. In theory, it should also make it easier for a nimble, upstart competitor without the legacy legal costs to enter the market and eat the lunch of the big banks, in much the way that the tobacco settlement gave a boost to brands that weren't part of the original lawsuits. But that's not likely to occur in this case because of all the extra regulation we've been piling on the sector.

All that regulation requires a big, expensive compliance operation and contacts in the Securities and Exchange Commission to help you negotiate the rocks and shoals of an ever-more-complex regulatory code. Which, in turn, makes it very difficult to start a new bank or turn a little one into a big one.

Ironically, the greatest legacy of the financial crisis may be to entrench the old elite bulge-bracket firms -- now known as the "too big to fail" banks, or "systemically important financial institutions" -- even more deeply at the apex of Wall Street's giant money pile.

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