Breaking up the Too Big to Fail and Too Big to Manage

As Bloomberg reports, the issue of breaking up the Too Big to Fail or Too Big to Manage is once again being kicked around in Washington.

Regular readers know that there is a simple way for Washington to break up and prevent the future formation of these institutions:  require that they and all other banks provide ultra transparency and reiteration of the no future bailout policy.

By requiring the financial institutions to disclose on an on-going basis their current global asset, liability and off-balance sheet exposure details, Washington is giving market participants the information they need to independently assess the risk of these institutions.

The incentive to do this assessment is substantial given that the market participants are responsible for all losses that result from this exposure under the no bailout policy.

The result will be that market participants adjust both the amount and pricing of their exposures to reflect their assessment of the risk of these institutions.

A higher cost of funds and a lower stock price acts as a stimulus for management to shrink both the size and complexity of their organizations.  Management, rather than regulators, breaks up the TBTF and Too Big to Manage.

Move over too-big-to-fail. Here comes too-big-to-manage. 

Congress’s inquiry into JPMorgan Chase & Co. (JPM)’s $2 billion trading loss has reignited the question of whether a bank can grow too large and complex for its own executives to oversee. 

The banking industry is taking notice that a move to cap the size of Wall Street firms is gaining traction on Capitol Hill. 

“There seems to be growing interest in some type of breakup proposal,” said Sheila Bair, a former chairman of the Federal Deposit Insurance Corp. 

The concept is expected to arise today as JPMorgan Chief Executive Officer Jamie Dimon testifies before the House Financial Services Committee on the trading debacle. Last week he told the Senate that the losses, which carved about $23 billion from the bank’s market value, were due to a poor investing strategy coupled with management failures. 

Senator Sherrod Brown seized on that admission. 

“It appears executives and regulators simply can’t understand what is happening in all these offices at once,” the Ohio Democrat said during the June 13 hearing. “It demonstrates to me that too-big-to-fail banks are, frankly, too-big-to-manage and too-big-to-regulate.” 

While bank lobbyists say they are still most concerned that JPMorgan’s trading loss could prompt regulators to write a stronger U.S. rule against proprietary trading, they are also closely monitoring the emerging talk about too-big-to-manage.

The financial industry fears the idea could unite Democrats pushing to downsize banks with Republicans who think the 2010 Dodd-Frank law should be repealed because it offers special regulatory protections to “systemically important” firms. 

Shifting the terms of the political debate from the more amorphous phrase of too-big-to-fail may make the efforts easier to explain to the public, said the lobbyists, who spoke on condition of anonymity because the discussions are private. 

Both Democrats and Republicans are weighing versions of too-big-to-manage proposals. 

Brown has sponsored a bill that would cap the size of what he calls “mega-banks.” FDIC member Thomas Hoenig has been promoting a modern version of the 1933 Glass-Steagall Act, aimed at separating more risky investment banking operations from units handling deposits.