Bernie's Bad Break

Right problem, wrong solution.

Photographer: Michael Nagle/Bloomberg

In some quarters of the Democratic Party, apparently, it's no longer enough to call for the breakup of the big banks: You have to pledge to do it faster than your rivals. That may explain Bernie Sanders's promise on Tuesday to "break 'em up" within his first year in office.

This is hardly a model of thoughtful policy making. For one, the government is not the best judge of how financial institutions could be efficiently divided. Beyond that, even smaller and more focused institutions can cause a lot of damage, as the 2008 demise of Lehman Brothers (a pure investment bank) and the savings and loan debacle of the 1980s eloquently demonstrate. A common factor was their inability to handle losses.

A smarter approach is to require that financial institutions employ more equity capital -- that is, money from shareholders -- so they can better absorb losses. Under current rules, the largest banks must have enough equity to absorb only a 5 percent net loss. That's more than before, but hardly adequate to prevent the kind of distress that can damage the economy.

Capital Requirements

Raising the level would make the system more resilient and also improve market discipline: If shareholders had to bear fuller responsibility for a bank's risks, they might see a case for dividing it into smaller, more manageable units. How and whether to do so, of course, would be up to the shareholders.

Higher capital requirements have the added advantage of being more politically feasible than a straight bank breakup. Some Republicans, such as presidential candidate Jeb Bush, have suggested policies that go in this direction.

Sanders, the second-leading Democratic presidential candidate, is not wrong to be concerned about the risk financial institutions pose to the U.S. economy. Unfortunately, his proposed solutions are inadequate.

To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net.