The Eternal Life of American Megabanks

The world economy is facing a serious problem: The largest banks in the U.S. are still “too big to fail.” The magnitude of the problem has been recognized not only by the authorities, but also by the bankers themselves. Jamie Dimon, the influential CEO of J.P. Morgan Chase, believes that the time of “too big to fail” is over.

Unfortunately, the solution advocated by the Obama administration to remedy the situation is not a viable option. The financial sector reform plan proposed by Sen. Christopher Dodd, currently being debated in the Senate, plans the creation of a process of “resolution” in the form of a government agency having the legal capacity to manage an orderly bankruptcy. The project’s supporters argue that this approach builds on the success of the Federal Deposit Insurance Corporation (FDIC), which has a long history of bank closures of small and medium size. In this context, the process of “resolution” for a bank means the dismissal of its officers and shareholders, and the dissolution of losses to uninsured creditors. It is essentially a form of bankruptcy, with a little more discretion!

But the implementation of this mechanism, seemingly perfect, in practice has an insurmountable difficulty for large institutions. Imagine the critical moment when a decision must be made regarding the possible bankruptcy of a mega-bank like J.P. Morgan Chase, whose assets amount to about $2 billion. You are a high-level decision maker, you are armed with the process of “resolution,” Dodd, and you begin the meeting, well determined to not help the bank in difficulty. At that time, someone reminds you that J.P. Morgan Chase is a complex global financial institution. The Dodd device determines the conditions of recovery in the U.S. only and not in the dozens of other countries with operating subsidiaries or other entities. Then these will simply go into bankruptcy, for which various governments will try to find makeshift solutions.

The consequences of uncoordinated responses would be frightening and at the edge of chaos. This is exactly what happened to Lehman Brothers. The existence of a process of “resolution” does nothing to limit the damage or panic. A failure of this kind could be managed in a more orderly way through a transnational regulator. But no such mechanism exists, nor will exist in the foreseeable future. Policy makers in other countries of the G-20 are very clear on this point: No one should adopt a specific way of managing the bankruptcy of a large international bank.

If J.P. Morgan Chase or any of the six largest U.S. banks go bankrupt, the same question from September 2008 will arise: Will you come to the aid of the bank or let it go bankrupt? Skip back or not, is it time to find a solution to save the system on public funds? It is likely that the second alternative prevails. When things go wrong, it is much less scary to save a mega than let it sink. And, of course, the loans markets know why they pay a lower rate to J.P. Morgan Chase, other major banks and the smaller banks that could really go bankrupt. Larger banks may well become even greater. And the bigger they are, the more creditors are safe. And the more the overall consequences will be catastrophic.