In my opinion, regulators should not “break up” the banks that are “too big to fail” (“Big Banks”) nor should they place restrictions on their growth, per se. Instead the regulations and capital requirements should change. If I were Chairman of the FDIC, I would suggest the following (as a start) to all of the bank regulatory agencies:
(1) Ratchet up capital requirements as banks pass certain asset-size thresholds. Citigroup, for example, should carry at least TWICE as much capital (on a percentage basis) as a plain vanilla community bank. Currently all the banks are treated equally from a capital standpoint.
(2) Re-define allowable banking activities. If you want to operate with FDIC insurance, there are certain things you just can’t do, including (a) proprietary trading, (b) investing in hedge funds and private equity, etc. etc.
(3) Place much greater restrictions on derivatives and Level 3 investment activities.
(4) Require greater diversification within the loan portfolio (most the Big Banks were allowed to get over-concentrated in certain areas)
That would be a huge start. I think it’s unnecessary to break up these big behemoths. Instead, the capital requirements and regulations should change which turn them into, in effect, public utilities. Instead of earning 25% ROEs in the good times and nearing the brink of failure in the bad times, they should be earning 8%-10% ROEs year in and year out. The problem is that from management’s perspective, well, that’s no fun (and they wouldn’t make as much money)… so they’re going to fight all of this stuff.
