“Too Big To Fail” Legislative Talk Has Disturbing Overtones

Just about everybody except bank executives with a vested interest agrees that some legislative changes need to be made in the wake of last year’s banking crisis. However, legislating in the wake of a crisis is not without risk — sometimes an overreaction can exacerbate a crisis.

In a subtle way, one has to look no farther than the low level of today’s low savings account interest rates, CD rates, and other bank rates to see an example. The government has made an all-out effort to push interest rates lower as a stimulative measure in the wake of last year’s difficulties. The unintended consequence is that low bank rates make it more difficult for banks to attract depositors — and thus this limits an important source of capital to banks that are trying to rebuild their capital reserves.

More famously, the U.S. government responded to the onset of the Great Depression by passing the protectionist Smoot-Hawley act in 1930 — and by thus isolating the U.S. economy only deepened its difficulties.

Now, House Financial Services Committe Chairman Barney Frank is advocating legislation creating extraordinary power for the government over large banks should they be in danger of failing. Some of the associated proposals — such as wiping out the property rights of equity holders under such circumstances — seem little more than vengeful. Worse, they could have the unintended consequence of making it impossible for banks to attract investment capital just when they need it the most.

Some anger at the banking community after last year’s debacle is understandable. However, rather than taking a pound of flesh, Congress should be looking at how to structure the industry so as to reduce the likelihood of failures in the first place.