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BEHEMOTH: The headquarters of HSBC Holdings in London.
Simon Dawson/Bloomberg via Getty Images
BEHEMOTH: The headquarters of HSBC Holdings in London.

'Too big to jail'

Banking |  Are the world’s biggest banks beyond the reach of the law?

Issue: "Day of reckoning," June 14, 2014

U.S. Assistant Attorney General Lanny Breuer seemed to hit hard in December 2012 when he announced that global banking giant HSBC would pay the government a fine of $1.9 billion. HSBC, he said, permitted “narcotics traffickers and others [to] launder millions of dollars through HSBC subsidiaries, and to facilitate hundreds of millions more in transactions with sanctioned countries,” including Cuba, Iran, Libya, Syria, and Myanmar.

Breuer said HSBC had a multiyear “record of dysfunction” and was guilty of a “stunning failure of oversight.” But he did not mention that the settlement allowed HSBC to avoid a criminal conviction that would have blocked the global bank from the U.S. banking system—what court watchers call a “death sentence.” In his triumphal announcement, Breuer also failed to mention that HSBC had earned more than $21 billion in 2011, and more than $20 billion in 2012. The fines amounted to less than 10 percent of its profit for a single year.

In March 2013 Breuer’s boss, Attorney General Eric Holder, went before the Senate Finance Committee to explain why HSBC wasn’t indicted for these crimes. He said some banks may be too large to prosecute without wrecking the economy. Holder’s “too big to jail” comments caused an immediate uproar. Sen. Charles Grassley, R-Iowa, the ranking Republican member of the Senate Judiciary Committee, said “big bankers know that if they commit financial crimes, they can expect a passive response from the Justice Department.”

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The one-year anniversary of Holder’s remarks has created new interest in the questions: Have banks become too big to fail, and too big to jail? According to Mark Calabria of the Cato Institute, “Banks are not too big to fail, but the bailouts created an impression they are. The notion of ‘too big to fail’ is a problem created by a perception the government will intervene, and that prevents market forces from working.”

Tony Plath, a professor of finance at the University of North Carolina-Charlotte, not far from the headquarters of Charlotte-based Bank of America, takes a slightly different view. “The Big Four banks [JPMorgan Chase, Bank of America, CitiGroup, and Wells Fargo] are too big to fail in the sense that I don’t think there’s anything the government can do to them.” He says the government has tremendous resources, “but so does Bank of America. It’s a $2 trillion bank.”

Plath and Calabria both say that legislation enacted in the wake of the financial crisis—particularly the Dodd-Frank Wall Street Reform and Consumer Protection Act—has made matters worse. “To begin with,” Plath said, “Title 1 and Title 2 of Dodd-Frank are in direct contradiction.” Title 1 created the Financial Stability Oversight Council (FSOC) that can designate financial institutions as creating “systemic risk” if they fail. This is the so-called “too big to fail” list. Title 2 provides for the orderly distribution of assets of those financial institutions not on that list that do fail. Critics of Dodd-Frank say these provisions send mixed messages to the markets.

Calabria and Plath also criticize the FSOC’s broad authority to keep adding banks to the “too big to fail” list. They say the risk to the banking system of letting a big bank fail has been dramatically overstated. If a lot of big banks failed simultaneously, that would be a problem. But Calabria believes government bailouts and excessive government intervention—not bank failures—are the real threat to the banking system. “The current system of securities law is broken,” Calabria said. “It undermines market discipline.” That’s why House Financial Services Committee Chairman Jeb Hensarling, R-Texas, told Treasury Secretary Jacob Lew that the FSOC should “cease and desist” designating more financial firms “too big to fail” during a hearing on May 9.

“There is increasingly bipartisan concern about the immense discretionary power that FSOC has and how little transparency there is,” Hensarling said.

The answer to the second question—are banks too big to jail?—is a bit more complicated. “Banks don’t do things. People do things,” Calabria said. Even if the failure of some large institutions poses systemic risks to the financial system, “it doesn’t threaten the institution to convict a person who behaves illegally, so there should be no reason not to pursue individuals guilty of wrongdoing.” But, while banks tend to settle and move on, individuals tend to fight. “If you’re a bank executive, you don’t want to go to jail, so you will defend yourself vigorously,” Calabria said. That’s why so few individuals get convicted. In the aftermath of the 2008 financial crash related to mortgage-backed securities, authorities arrested two Bear Stearns officials, Matthew Tannin and Ralph Cioffi. Bear Stearns ultimately went out of business after JPMorgan Chase bought the firm—with a $29 billion loan from the U.S. government—but Tannin and Cioffi were ultimately found not guilty of misleading investors.

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