The heated debate about banks being too big to fail has resumed as the Presidential election heats up.
Vermont Senator and Democratic candidate Bernie Sanders has been floating a plan to establish a sort of 21st century Glass-Steagall Act to separate commercial banking activities from investment banking-style activities, such as derivative trading. Some observers of banking and consumer activists call the latter shadow banking.
Recently, Minneapolis Federal Reserve Bank president, Neel Kashkari echoed these concerns when he said that the economy and taxpayers are still at risk because current banking laws are inadequate. He suggested that massive banks should be broken up. The original Glass-Steagall Act provided for this but was repealed in 1999 with the passage of the Gramm-Leach Bliley Act.
The discussions underscore society's mixed feelings about the financial services industry. Most families need banking services, and rely on big banks, even as they accuse them of greed and irresponsible behavior. Many consumers still bristle over the Federal government's massive bailout following the 2008 meltdown. They do not believe that the 2010 Dodd-Frank Act addressed the issue of size. Over the last seven years, one of every four community banks has disappeared but the biggest banks have gotten 80% larger they were one year before the financial crisis in 2008.
Critics say also that there is a bigger problem: The interconnectedness between banking and other industries, including firms within the financial services sector, created wider problems. When banks struggled the impact on other companies was more significant than it should have been. Moreover, some observers say that the bailout created an atmosphere that encouraged excessive risk-taking in an industry that by its nature should be careful. Banks have felt comfortable taking chances because they know that they may receive a life line if things go sour again.
Annual stress tests requiring that banks meet capital requirements have not addressed interconnectedness and big banks' influences. Whether Sanders' proposal is the best solution is questionable. But it may be time for the banking industry and regulators to take stock of itself again.
Banks were not too big to fail once. They are likely not too big to fail again, and to take other parts of the economy with them.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.