Are Too Big to Fail Banks Too Dangerous?

President of the Federal Reserve Bank of Dallas Richard Fisher said, “I believe that too-big-to-fail banks are too dangerous to permit.” Big banks (NYSEARCA:KBE) and market forces don’t work because the banks have enormous political power and receive almost unlimited, implicit subsidies in the form of protection against downside risks — especially in times like these, with Europe’s financial situation looking uncertain.

Mr. Fisher also said, “Downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response. Then, creative destruction can work its wonders in the financial sector, just as it does elsewhere in our economy.”

Vikram Pandit, the chief executive of Citigroup (NYSE:C), went on record with The Banker magazine and explained how his bank will generate shareholder value. Citigroup, one of the world’s largest banks, has about $2 trillion in total assets. The firm is number 39 on Forbes’ list of top 500 global companies.

Is there indication in Mr. Pandit’s vision that mega-banking will be good for the rest of us in the future?

Mr. Pandit’s won’t be pressing his view on mega-banking on the consumer market in the US. He just wants to cut back on that part of his business. The engines of growth, Mr. Pandit said, will be “the global transactions services business” and “emerging markets.” Transaction services are essential, but they do not need a very big balance sheet. They can be easily done by a network of small financial firms.

Global commerce was around way before banks built up risks that are large relative to their home economies and emerging markets are risky. Mr. Pandit is basically betting that Citibank can ride the cycle in those countries. There will probably be profits and this will substantiate high compensation levels. Nevertheless, as it did in 1982, the cycle will turn against emerging markets.

Citibank (NYSE:C) had a large loan exposure in the emerging markets in 1982 and it was saved from by “regulatory forbearance,” meaning that the Federal Reserve and other regulators did not force it to recognize its losses. The point being a collapse of a bank like Citibank would not be good!

Others like Jon Huntsman and Newt Gingrich are also both joining the cause that banks are getting too big. Whoever ends up running against Mitt Romney will most likely use this idea since he has so much financial support from the top of Wall Street.

Like Mr. Fisher put it, “Perhaps the financial equivalent of irreversible lap-band or gastric bypass surgery is the only way to treat the pathology of financial obesity, contain the relentless expansion of these banks and downsize them to manageable proportions.”

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