WASHINGTON, D.C. –U.S. Sen. Sherrod Brown (D-OH), chairman of the U.S. Senate Banking Subcommittee on Financial Institutions and Consumer Protection, conducted a hearing today entitled, “Debt Financing in the Domestic Financial Sector.” The hearing examined how our nation’s largest banks – by virtue of their “too big to fail” size – receive what amounts to a free “guarantee” at the expense of taxpayers and competitors. The hearing examined if this provides an unfair advantage to the nation’s largest banks over other banks and financial institutions when it comes to attracting investment.
“We can’t allow collective amnesia to obscure the role that excessive financial sector debt played in causing the deepest recession since the Great Depression,” Brown said in his opening statement. “In nearly the last century and a half, U.S. banks’ capital ratios declined from about 25 percent to around 5 percent of total assets. And in the last two decades, the 10 largest banks nearly doubled their leverage – that is, the assets that they have available to pay off their debt.”
“The least we can do is ask the financial sector to have a prudent amount of its own money to cover its own losses,” Brown said. “Requiring greater capital will protect taxpayers and banks in the event of an economic downturn providing an equity cushion that will allow banks to continue making loans to businesses.”
Testifying at today’s hearing, the third in a series to be held by Brown entitled, “Banking that Benefits Main Street,” were: Joseph Stiglitz, Ph.D., professor of Finance and Economics, Columbia Business School, Columbia University; Edward Kane, Ph.D., professor of Finance, Boston College; Eugene A. Ludwig, CEO, Promontory Financial Group; and Paul Pfleiderer, Ph. D., C.O.G. Miller Distinguished Professor of Finance, Stanford University Graduate School of Business.
Below is the statement as prepared for delivery.
The recent debate was fixated on the national debt. But it was more than just the national debt that we should be worried about.
Too many people here in Washington seem to have forgotten about the debt that helped put us in a deep recession, impeded economic growth, stifled tax revenues, and cost taxpayer dollars.
And that’s the debt of the financial sector.
The Congressional Budget Office estimates the entire cost of rescuing our failing banking system – the bailouts, decreased tax revenues, new spending programs, and interest payments – will cost our nation $8.6 trillion. That’s more than 57 percent of our Gross Domestic Product.
We can’t allow collective amnesia to obscure the role that excessive financial sector debt played in causing the deepest recession since the Great Depression. In nearly the last century and a half, U.S. banks’ capital ratios declined from about 25 percent to around 5 percent of total assets. And in the last two decades, the 10 largest banks nearly doubled their leverage – that is, the assets that they have available to pay off their debt.
At the time of the financial crisis – in 2007 and 2008 – four out of the five largest investment banks were leveraged 30, 35 or 40 to 1. That means when their assets declined by even the smallest amount, they were unable to cover to pay their debts – they were essentially insolvent.
This overreliance on borrowing from other businesses makes the financial system so interconnected and interdependent that the failure of one firm can bring down the entire sector – if not the entire economy. And the implicit assumption that the government will backstop their losses gives companies an incentive to engage in what economists George Akerlof and Paul Romer have called “looting.”
In their words, companies “have an incentive to go broke for profit at society’s expense, instead of to go for broke.”
According Kansas City Fed President Tom Hoenig, the 20 biggest banks are more highly leveraged than their community bank competitors. The largest banks are able to borrow more cheaply than they otherwise would, because it is assumed that the government will step in to prevent them from failing.
As a result, the largest banks make bigger profits than those that do not enjoy government subsidies. They are least able to weather an economic downturn because of their significant leverage. And, incredibly, the largest banks are even bigger than before.
Prior to the crisis in 2006, the top 10 largest banks contained 68 percent of total bank assets. By the end of 2010 they contained 77 percent of total banking assets. Simply put, were there another economic calamity, bailing these banks out again would impose an even higher cost on taxpayers.
This is not capitalism in any sense of the word. The easiest way to prevent the need for future bailouts is simple: requiring banks to hold increased capital buffers. Capital buffers simply require banks to fund themselves using their own money instead of other people’s money.
Last Tuesday, the Ranking Member of the full committee, Senator Shelby, said that, “One of the lessons of the financial crisis should be the importance of maintaining strong capital requirements, especially for large global banks.”
I could not agree more. The least we can do is ask the financial sector to have a prudent amount of its own money to cover its own losses.
We require as much of our community banks, and the same rules should apply to everyone. And that’s why this hearing is so important.