Republic, Lost_ How Money Corrupts Congress--And a Plan to Stop It - Lawrence Lessig [86]
The simplest way to achieve this real reform would be to force banks back to a smaller size.44 A promise by the government not to bail out banks is credible only when banks are small. It is not credible when banks are “too big to fail.” Thus, as Simon Johnson and James Kwak recommend:
(1) A hard cap on the size of financial institutions: no financial institution would be allowed to control or have an ownership interest in assets worth more than a fixed percentage of U.S. GDP. The percentage should be low enough that banks below that threshold can be allowed to fail without entailing serious risk to the financial system. “As a first proposal, this limit should be no more than 4 percent of GDP, or roughly $570 billion in assets today.”
(2) A lower hard cap on size for banks that take greater risks, including derivatives, off-balance-sheet positions, and other factors that increase the damage a failing institution could cause to other financial institutions. “As an initial guideline, an investment bank (such as Goldman Sachs) should be effectively limited in size to two percent of GDP, or roughly $285 billion today.”45
This reform would have produced a market of banks that were not so big that the government would have to save them. These banks would therefore live life like any other entity in a competitive market, keen to make money, but careful not to take on unnecessary or extreme risk. The market would thus be the ultimate and efficient regulator, because the market would not forgive failure. Bankruptcy would be the remedy for failure, not a blank check from the Federal Reserve.
Yet the banks fought this obvious reform with fury, and succeeded. As Lowenstein describes it, “Wall Street institutions emerged from the crisis more protected than ever.”46 “For better or worse,” as Tyler Cowen wrote after the reform bill was passed, “we’re handing out free options on recovery, and that encourages banks to take more risk.”47 Hacker and Pierson quote “two New York Times reporters describing Wall Street executives as ‘privately relieved that the bill [did] not do more to fundamentally change how the industry does business.’ ”48 Sebastian Mallaby “put [it most] simply”: “government actions have decreased the cost of risk for too-big-to-fail players; the result will be more risk taking. The vicious cycle will go on until governments are bankrupt.”49
How was this non-reform reform bill passed?
Contributions by groups opposed to even the much tamer reform bill that Congress passed were more than $25 million, two and a half times the contributions of groups supporting the reform. Likewise, lobbying in 2010 by interests opposed to reform was more than $205 million. Lobbying by interests supporting reform: about $5 million.50 The result: The critical reform necessary to secure our economy has not been made. Our banks were too big to fail in the past. They have only gotten bigger, with even more certainty that they will not be permitted to fail in the future.
Former chairman of the SEC Arthur Levitt describes the dynamic perfectly:
During my seven and a half years in Washington… nothing astonished me more than witnessing the powerful special interest groups in full swing when they thought a proposed rule or a piece of legislation might hurt them, giving nary a thought to how the [battles over corporate reform] might help the investing public. With laser-like precision, groups representing Wall Street firms… would quickly set about to defeat even minor threats. Individual investors, with no organized