Plosser Gives a Speech on the Troublesome Topic of Breaking Up Too Big To Fail

“Charles Plosser, President and Chief Executive Officer of Federal Reserve Bank of Philadelphia, gave a speech on Thursday afternoon discussing how to end the “Too Big To Fail” conundrum of the big banks at the fourth Annual Simon New York City Conference. We are not interested in regurgitating Plosser’s speech today. What we want to show you is how and why the “too big to fail” conundrum cannot easily be solved and why it is so difficult to just unbundle the concentration of risk here.

This is an interesting take because it has yet another call to increase the capitalization of the so-called too big to fail banks. It sound great and 24/7 Wall St. is all in favor of big banks being on solid ground. The ultimate problem is that the big banks are so big that increase their capitalization requirements effectively withdraws too much capital from the economy.  It is without any doubt that you have heard of the calls to break apart the big banks before. You will here those same calls tomorrow and beyond as well.

When you consider that a mere handful of banks have about half of the country’s personal and commercial bank deposits you have a right to be scared. Increasing the capital requirements above the 10% hurdles set by Basel banking standards. Imagine how strong and able these banks would be able to hold up in another recession if their bank capital requirements went from 10% to say 15%.   Now for the bad news if you look at the tally of assets as of the end of 2012. J.P. Morgan Chase & Co. (NYSE: JPM) was about $2.36 trillion in assets and Bank of America Corporation (NYSE: BAC) has $2.2 trillion in assets, with Citigroup Inc. (NYSE: C) behind it at $1.86 trillon and then followed by $1.42 trillion for Wells Fargo & Co. (NYSE: WFC).

These four banks alone have $7.84 trillion in assets. The CIA World Factbook tracks just about all global economies and its final estimate for 2012 GDP was put at $15.66 trillion for 2012. Different regulators have many different means of calculating what they think the capitalization are best and keeping up with the flavor of the day or week is for government accountants and regulators. Still, this asset base for just the four biggest banks is right at half (actually 50.06%) of 2012 GDP on the purchasing power parity calculation preferred by economists.

It is very easy to merely say in a vacuum that the too big to fail banks should just increase their capital to hedge against future bailouts. Various regulators have various means of evaluating capitalization metrics and requirements. The unfortunate outcome is that by forcing banks to hold even more capital will tighten credit even further than it has been. With much of the world back in recession, that puts the U.S. back in recession.

Here is what Mr. Plosser said….”

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