The Wonk Room

Grassley: ‘Too Big To Fail’ Banks Aren’t Really A Problem

Today, Sen. Charles Grassley (R-IA) appeared on CNBC to discuss President Obama’s financial regulatory package, which is being rolled out tomorrow. While he was broadly supportive of the proposed reforms, Grassley has evidently come to the conclusion that there is no problem with financial institutions being “too big to fail,” because the current crisis was caused by banks simply going broke:

Listen, the banks got into trouble not because they were too big but because, simply, they were broke.

Watch it:

Yes, banks going broke was part of the problem. But small banks go broke all the time without threatening the entire financial system and requiring billions in federal bailout money. This year alone, the Federal Deposit Insurance Corp. has closed down 37 different banks.

But other institutions — think Citigroup — were so big, complex, interconnected, and tied up in non-traditional banking instruments that they couldn’t go bust without taking a sizeable portion of the financial world down with them. And that was the real problem. For instance, AIG, which isn’t even a bank, sold so many credit default swaps — and thus had so much outstanding debt that it couldn’t cover — that its failure could have pulled down a host of other institutions.

As part of its regulatory reform package, the Obama administration is asking for a resolution authority “to allow the unwinding of troubled non-bank financial institutions.” And while the plan will reportedly include higher liquidity and capital requirements for larger banks, I wish there was a bit more emphasis on the approach to banks advocated by Paul Volcker, chairman of the Economic Recovery Advisory Board: “Keep them small, so that any failure won’t have systematic importance.”