Curious Capitalist

Post Volcker Rule, Banks Still Aren’t Safe Enough

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Seth Wenig / AP

JPMorgan Chase & Co. headquarters in New York CIty, on Oct. 21, 2013.

FDIC vice chairman Tom Hoenig, perhaps the smartest banking reformer around, gave an important speech in Europe this week. His talk, entitled “Global Banking: A Failure of Structural Integrity,” gets at exactly why, despite all the hoopla this week over the passing of the (very much modified) Volker Rule, our financial system isn’t really safer than it was before the 2008 crisis.

One of the most telling figures in Hoenig’s speech was buried in the middle: from 2008 to 2011, commercial and industrial loans to American businesses declined from $1.6 trillion to $1.24 trillion. While banks would argue that this is because demand fell off post financial crisis, the Alliance for American Manufacturing argues that it was because credit tightened so dramatically. I’m inclined to believe the manufacturers, since they’ve actually been having a substantial renaissance in recent years, and manufacturing recoveries historically pre-date larger consumer recoveries.

The point is that banks used to be the servants of American business. Now, they are its masters. Hoenig believes this is because even post-Volcker, giant banking conglomerates aren’t being broken up into smaller entities, divided along business lines (i.e. commercial lending, investment bank, trading, etc.), which would eliminate conflicts of interest that still exist as well as the Too Big To Fail (and Manage) problem. “I’m not sure [even with the Volker Rule] that customers are safer and the financial system is stronger,” he told me. “These big institutions need to be split up. I don’t know any manager who can safely handle one institution that’s holding $3-4 trillion of assets. It’s just too big.”

Indeed, Hoenig makes a persuasive case that banks themselves would become more profitable if they were split up (many of the largest and most complex firms trade at a discount from book value, suggesting that the market isn’t confident about their future performance). Certainly, it would help the rest of American business – the fact that the five largest US financial holding companies control 55 % of all industry assets (versus 20 % in 1990) keeps industry competition low and credit constrained.

So, where do we go from? I think we’re in for 2-5 years of legal wrangling about the details of Volcker, and how they’ll affect banks’ business models and whether or not it will do much to reduce risk. It’s very likely that we’ll see more banking scandals during that time, which will increase the drumbeat of calls for further reform. Hoenig, for one, agrees, and looks to money market funds and the repo market as possible sources of future crisis. Until big banks get smaller, it’s very likely we’ll see another crisis.

“Something will happen,” he says. “It always does.”