The Beginning of "Too Big To Fail"

The 1990s were a time of massive deregulation. Most people have some familiarity with the repeal of the Glass Steagall Act, which kept a "Chinese Wall" between the activities of commercial banks and securities firms. But most people have never heard of a piece of legislation called the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, and it could be argued that it was this piece of legislation that played a far bigger role in the forces that shaped the financial crisis of 2008.

While most of the legislation that was dismantled over the course of time have their roots in the Depression era, Riegle-Neal removed a constraint that was passed in 1927: The McFadden Act, which was passed in order to restrict the concentration of banking power, which would have eliminated competition, make smaller institutions uncompetitive, and give large institutions a considerable amount of political and economic leverage.

The McFadden Act allowed a national bank to operate branches to the extent permitted by state governments for state banks in each state. In a state that prohibited branch banking, for example, if a bank wanted to operate in another state, it had to set up shop as a separate corporation to conduct business there, similar, in a way, to how insurance companies are regulated, with each state having it's own commissioner and regulations, even though a firm like State Farm may operate across the country. McFadden also placed restrictions on the ability of one bank to purchase another bank in another state. This too, to restrict concentration of assets. This arrangement fostered the ability of local banks to operate, and if an organization like Fleet Bank wanted to do business or open branches in other states, it formed a corporation to do business in that state. Banks like Fleet, Norwest, CoreStates Financial, et.al., eventually became known as “super regionals.” These were not small operations by any stretch, but as long as they had siloed their operations in each state they conducted business, they were in compliance with the law, and they could not set up shop on the basis of an acquisition.

Then, under the guise of "modernization," Reigle-Neal was signed into law. And here is what happened afterwards.

Almost immediately after the restrictions on interstate banking were lifted, institutions small and large consolidated, and by 2000, a great deal of assets had been concentrated into a handful of banks. This set the stage for the debacle that was to come, including the massive bailouts that were done after the fall of Lehman Brothers in September of 2008. The crisis then consolidated even MORE organizations into fewer hands, with troubled firms like Countrywide, Washington Mutual, and Wells Fargo swallowed up.

And that is the quick and dirty on how "Too Big To Fail" came to be. Today, it is estimated that just five banks hold half of the banking assets in the United States, and there are many cries to "break up the big banks" heard. Which I believe may be a good thing to do, except there is scant detail about just how that is going to be accomplished. Do we repeal Riegle-Neal? Break up the banks as we did with Ma Bell? And when we do, how will the accounts of millions of depositors be re-allocated? And now that banks are merged into securities firms, how do we untangle all of those assets?

If banks thought implementing Dodd-Frank was a costly headache, they'll be pining for the good old days of bearing the burden of being a "systemically important financial institution."