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Are Large Regional Banks Systemically Risky?

April 20, 2022

By William Isaac

Mergers among large regional banks have become a hot button topic of late, resulting in a recent feud among the board members of the Federal Deposit Insurance Corporation. Acting Comptroller of the Currency, Michael Hsu, raised the issue again recently at a Wharton Financial Regulation Conference.

I applaud the Acting Comptroller for highlighting and pursuing this issue. It’s important that we have this policy debate in the open so we are ready to deal intelligently with the next banking crisis before it arises. The last thing we need is a repeat of the grossly mishandled crisis of 2008-2010 led by the Treasury rather than the Fed and the FDIC. That calamity was followed by a very costly lost decade for the US economy.

A top priority going forward should be to avoid another massive taxpayer outlay along the lines of the $700 billion outlay then Treasury Secretary Hank Paulson demanded and received from Congress in the Troubled Asset Relief Program legislation of 2008 (“TARP”). It was a terrible idea for the government to purchase troubled assets from financial institutions, as evidenced by the fact that the TARP program as sold to Congress was never implemented.

Instead, the Treasury used the $700 billion slush fund to bailout car companies, insurance companies, Wall Street firms and nearly everything else in sight. Significant regional banks such as WaMu and National City, which could have easily been kept from failing, were forced to be taken over by larger banks, without even a bidding process, rather than waiting for the crisis to abate before deciding what needed to be done.

Major Wall Street firms were obliterated at great cost to our economy when they could have been stabilized and dealt with much less expensively in a less frantic atmosphere. Bank of America was ordered to purchase Wall Street’s largest firm and retail giant, Merrill Lynch, causing massive problems at our nation’s most important retail bank and helping to create significantly more concentration in financial services throughout the nation. This in turn led to mergers of other regional banks.

Acting Comptroller Hsu and other regulators are right to devote attention to how prevent another material increase in concentration in financial services, particularly when significant financial institutions experience serious troubles. He is rightly concerned about the possibility of tucking troubled regional banks into already too-big-to-fail global banks.

Large banks are already required to develop and maintain living wills which spell out their plans for downsizing and even resolution should they get into serious trouble. They can be broken up and sold to other domestic and foreign banking companies in an orderly process, assuming we do not experience a concurrent breakdown affecting the entire financial system and economy.

Unfortunately, our government financial leaders in the 2008-2010 period did not reflect on how a potentially far more serious financial crisis was handled successfully during period from 1978 through the early 1992. Instead of implementing tactics similar to those employed under the leadership of the Federal Reserve and FDIC, in consultation with the Treasury, during the earlier period – implementing orderly resolutions of serious problems with as little fanfare as possible – government leaders turned what should have been a serious but manageable real estate debacle into a full-blown crisis.

The Treasury Secretary proclaimed to Congress and the media that the financial system was about to collapse if Congress did not enact a deeply flawed and enormously expensive TARP program immediately without debate. Government leaders yelled “fire” in a crowded auditorium and then seemed surprised when panic ensued. Even more panic was created by allowing or even causing one large institution after another to fail with highly inconsistent and unpredictable resolutions – bailing out some, letting others simply fail, and doing government-assisted deals on others.

I’m delighted Acting Comptroller Hsu is raising the questions he is raising about how we will handle the resolution of large regional banks should they get into trouble down the line. The question is critically important because the day could come again when regulators will need to deal with such issues.

I’m not particularly concerned about our ability to work our way through these potential problems in a fashion that maintains public confidence and stability throughout our financial system so long as we study and understand the successful resolution and restructuring of the financial system from the late 1970s through the early 1990s. And we must also study and understand the serious mistakes made during the 2008-2010 period and the lost decade that followed.