Fixing the Banks – A New Approach to National Banking Regulation

A strong economy needs a strong financial services sector. A strong financial services sector needs strong, viable, and competitive banks. Today’s American banking sector is in near collapse. The federal government has practically nationalized the big banks. The FDIC is nearly bankrupt. According to the FDIC’s Failed Bank List, the FDIC has closed 112 banks in the past year. From 2000 through September 2008, they closed 40 banks.

The banks have destroyed the housing sector. After Fannie Mae and Freddie Mac inspired loose lending, neighborhoods and cities across the country are being destroyed by foreclosures and banking processes that are driving down housing values even more. Sudden caps on equity lines, refusing short sale offers, then foreclosing, not maintaining foreclosed properties, and not paying assessments are destroying home values and killing the consumer economy.

At the same time, $700 billion of taxpayer money and debt obligation went to the financial sector through TARP to fund and save the very people who continue to keep the downward pressure on. The people were told the TARP bailouts would save the economy and keep credit available. Credit is certainly not flowing to businesses and good credit risks. Credit card rates are rising to the 30% range for even the best risks and payment histories. The housing sector is sinking horribly; the only saving grace is the $8000 credit for first-time buyers and that is set to expire soon.

The system needs fixing and traditional regulation is not the answer. Our proposed solution is based on the following fundamental beliefs:

• No bank should ever be too big to fail; Some banks must fail in order to keep the others in line and aware of the downside to poor performance.
• Banking has lost touch with local markets and customers.
• Competition results in better banking services and products at the lowest price to the consumer.
• More banks are better than fewer banks for the economy, for industry, for consumers, and for any geographic area.
• Consumer, mortgage, and business banking should be separate from investment banking.
• The government should never own equity in or control management of any bank.
• The government cannot regulate the risk out of the system, without destroying the economy; nor should it attempt to do so.
• The government cannot regulate good decision-making into any industry; it can only set guidelines and reduce the risk impact.

Our Proposal

The nation’s big banks are very big-too big for the government to bail out and too big for the economy to suffer the effects of banking failure. For sure, multiple big banks failing nearly simultaneously is the recipe for economic meltdown, as we have learned. No bank should be too big to fail. The government has to get out of the role of last line of defense. The incentive to take banking risks and claiming upside benefits while leaving taxpayers to clean up banking failures has to end, now.

So, we propose breaking up every large bank into smaller regional banks, 1980’s ATT-style. No federally-regulated bank should be allowed to do business in more than five US contiguous states. This will ensure:

• Strong regional banking services with regional flavor and local headquarters.
• Enough diversification to eliminate geographic and industry risk in business.
• A broad base of regional banks with products and services geared to regional needs.
• Interlocking state networks of banks will promote a variety of competition and quality services nationally.
• No banking failure can have a national impact.

For the purposes of the regulation, Hawaii will be deemed to be contiguous to Alaska, California, and Oregon. Alaska will be deemed to be contiguous to Hawaii, Washington, and Idaho. Maine can be deemed to be contiguous to Vermont and Massachusetts in addition to New Hampshire. Finally, Washington, DC will be considered a part of Maryland.

The proposal does not allow banks to cherry pick five states across the nation, for example New York, California, Florida, Texas, and Illinois. Instead a bank starting in California could compete in California, Arizona, New Mexico, Texas, and Louisiana. Or, the could compete in California, Hawaii, Oregon, Washington, and Alaska. A Florida bank could go as far west as Texas or as far north as Maryland or Illinois. But, in all cases, a bank is limited to five contiguous states.

A federally-regulated bank does not have to compete in five states; they can do business in one, two, three, or four states-as long as the states are contiguous.

Skipping states is not allowed. A bank doing business in Florida and South Carolina must also be active in Georgia (or around Georgia via Tennessee and Alabama).

Breaking up the big banks should not be too difficult. Banks should be split ATT-style via stock spin offs. None of the new “baby” banks shall have interlocking boards or shared directors. The new banks must be independent entities. They must have their own management teams and headquarters.

Central service organizations like information technology should be spun off into independent service companies. They can have 5-year contracts to service the family of former banking company owners. After that, they should compete in the marketplace to service banks or be acquired to be an in-house IT organization.

The new “baby” banks will be permitted to acquire and merge with other banks. However, they are limited to doing business within their five contiguous states. Market operations in other states must be sold or spun off prior to closing on a merger or acquisition.

The result of our proposal will be a stronger group of regional banks. These banks will be more in touch with regional needs and industries. Decision making will be more decentralized and more accountable.

Yet, each bank will be large enough to diversify geographic risk. No bank will be unwillingly tied to a single metropolitan area, housing market, or client industry. Banks will be large enough to specialize and to serve the needs of their consumer and corporate customers.

The geographic footprints of various banks should not match up exactly. Each state should have a unique and dynamic marketplace of competitors. For example, Maryland could have competition from banks based in New York, Florida, and Illinois.

Best of all, no bank will be too big to fail. No bank failure will have national implications.

If, in the future, the system is working well or there is the need to promote additional competition in selected “under served” states, Congress could increase the contiguous state limit to six or seven states. Or, they could deem “under served” states as one state for regulatory purposes (for example, North and South Dakota might count as a single state to encourage more local competition) at the request of the state legislatures.

Now is the time to fix American banking, once and for all.

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