Yves Smith is the pen name of Susan Webber, a principal of Aurora Advisors and publisher of the Naked Capitalism economics blog.

In one of their angrier exchanges before Tuesday’s New York primary, Bernie Sanders and Hillary Clinton squabbled in Brooklyn over who would do a better job of containing the giant banks across the river, the ones that nearly destroyed the U.S. economy in 2008. Only a few days before the debate between the two Democratic candidates, five of the eight banks tasked to write “living wills” as mandated by the Dodd-Frank law—JP Morgan, Bank of America, State Street, Bank of New York Mellon and Wells Fargo—got failing grades. That meant they couldn’t convince regulators they were capable of liquidating themselves in an orderly way in the event of a crisis like 2008—indicating, in turn, that absent a government bailout, the economy would take a huge hit again. Clinton declared that, as president, “I will move immediately to break up any financial institution” that couldn’t meet the test under Dodd-Frank. Sanders said he wouldn’t wait: “I don’t need Dodd-Frank now to tell me that we have got to break up these banks.”

The idea that this debate remains so unresolved nearly eight years after the Wall Street-generated crisis that nearly sank the world economy is a danger sign, especially since U.S. regulators are still not reckoning with the peril in the financial sector realistically, even as other countries have done a much better job than we have in fixing things.


The boldest has been Switzerland, with an economy far more dependent on banking than ours. As part of its rescue of UBS, the Swiss National Bank required UBS to conduct an independent investigation of how it got itself in such a mess. The report was made public, an unparalleled measure of forensics and accountability that should have been a universal practice. In 2010, Switzerland implemented new rules requiring its two banking behemoths, UBS and Credit Suisse, to have total risk-weighted capital of 19 percent, nearly double the level required under Basle III rules. UBS tried to domicile its investment banking operations in another country, only to find that none with a credible banking regulator (meaning an adequate too-big-to-fail backstop) would have them. Credit Suisse ring-fenced its Swiss operations, moving some of its riskier business to the United States and London so that, in the event of a crisis, they would ostensibly be adequately capitalized and able to fail as individual units, reducing the risk of contagion. Both banks also shrank considerably to meet the new capital rules.

In the United Kingdom, in marked contrast to the U.S. response, the Bank of England and the Financial Services Authority, which was one of three key banking regulators from 2001 to its abolition in 2013, were both highly critical of British banks after the crisis. This is more important than it might seem. A widespread failing in the United States is the degree to which banking authorities treat their charges with undue deference. At the Federal Reserve’s Jackson Hole conference in 2008, the group of bankers and regulators exploded in anger when former central banker Willem Buiter dared to point out the obvious, that the Fed had a bad case of “cognitive regulatory capture,” meaning it “listens to Wall Street and believes what it hears.” Or as German Finance Minister Wolfgang Schäuble put it: “If you want to drain the swamp, then you don’t ask the frogs for their opinion.”

The British regulators were less generous to banks during their rescues than ours were. Banks that received bailouts were barred from paying directors bonuses, subject to restrictions on executive pay, and required to continue lending to consumers and small businesses and in particular to help “people struggling with mortgage payments to stay in their homes.” The only similar measure in the US was minor restrictions on executive pay for TARP recipients.

The Bank of England and the FSA also pushed for more radical reforms than their U.S. counterparts did. They advocated strenuously for a breakup of banks along Glass-Steagall lines, separating retail banking and banking to small- and medium-size businesses from “wholesale” banking and investment banking. The U.K. Treasury was vehemently opposed, but the resulting reforms, set forth in the 2013 Vickers Report on banking standards, did include “ring-fencing” the retail and small-business operations in ways that go further than the watered-down measures in the U.S. In the U.K., the retail/small-business units segregate deposits from risky derivatives and trading activities. Those operations also have their own boards and publish financial statements as though they were independent. By contrast, the U.S. still allows banks to use consumer deposits to finance derivatives positions.

In a striking contrast to the Federal Reserve, the Bank of England has also provided intellectual leadership on the hazards created by big banks. Widely recognized as one of the most creative and original economists of his generation, Andrew Haldane, the BoE’s executive director of financial stability, has published a wide range of articles that lay waste the banking industry’s claims that it deserves kid-glove treatment. For instance, one favorite “keep-your-hands-off-the-regulatory-dial” argument is that banks are so valuable to the economy that they must be given free rein.

On the contrary, Haldane and other overseas regulators have argued that regulators should be treating the banks more as public utilities, like water or power, which are heavily regulated precisely because they are essential to the running of an economy. This is also something that is not discussed in U.S. regulatory circles. In a 2010 speech, “The $100 Billion Question,” Haldane concluded that the financial crisis of 2008-09 produced an output loss equivalent to $60 trillion to $200 trillion for the world economy. Assuming that a crisis occurs every 20 years, he said, overall that means that a poorly regulated financial sector does not add any net benefit to the economy—its repeated crises cost far more than Wall Street brings to overall economic growth. Haldane compared the speculative trading excesses of bankers to air pollution from the auto industry and wrote that “systemic risk is a noxious by-product” not unlike the damage to public health from carbon monoxide, lead and other toxins. In the auto sector, those problems were redressed through taxation and occasional prohibitions or restrictions on poisonous emissions. Why not take a similar approach to over-the-counter derivatives?

Haldane used a 2008 crisis cost of one times global GDP, the low end of his estimated range. That sounded large at the time but has proved to be about right. Haldane then tried the tax approach: make the big banks pay for the cost of the crisis over 20 years, which is about how often big busts occur in our deregulated world. The first-year charge alone would wipe out the banks. Or as Haldane colorfully put it: “Fully internalizing the output costs of financial crises would risk putting banks on the same trajectory as the dinosaurs, with the levy playing the role of the meteorite.” The implication was that barring banks from crisis-inducing behavior was the best remedy, regardless of the impact on profits, since banks could not begin to pay for the costs of financial meltdowns.

Dire tradeoffs that clear-cut mean that there’s no justification for the timid approach that U.S. and many foreign regulators have taken to systemically risky banks. Haldane’s opus confirms the popular instinct: Bankers need to be leashed and collared—and the sooner, the better.

But despite the rise of Bernie Sanders—on a largely anti-Wall Street platform—U.S. policymakers are having little of this discussion. The Fed and the Federal Deposit Insurance Corporation told the banks to submit more viable plans by October or face sanctions, such as restrictions on dividends or acquisitions. Even the two that regulators gave split reviews, Goldman and Morgan Stanley, and the one that received a pass, Citigroup, must provide improved plans by July 2017. But U.S. regulators are still going on the assumption that the plans can be made viable.

It’s unlikely banking officials would have gone even this far in the absence of rising political pressure. Massachusetts Sen. Elizabeth Warren called out Fed chair Janet Yellen in a 2014 hearing for failing to determine whether the living wills that systemically important banks had submitted annually were credible. Public dissatisfaction with the failure to prosecute bank executives has only increased as stories of bank lawlessness—ranging from the manipulation of Libor (the London Interbank Offered Rate, which is the average of interest rates estimated by each of the leading London banks that they would be charged were they to borrow from other banks), foreign exchange and Treasury market manipulation, money laundering, and, with the Panama Papers, facilitation of tax evasion—have become almost a daily staple. Another vote of no confidence comes from new Minneapolis Fed President Neal Kashkari, who is hosting a series of high-profile conferences and soliciting a wide range of ideas as input for presenting the Minneapolis Fed’s own plan for solving the too-big-to-fail problem toward the end of the year.

Skeptics are right to harbor doubts. For instance, the recent living-will reviews deemed Morgan Stanley and Goldman to be sketchy on how they’d wind down their derivatives positions. In fact, there’s no tidy way to shutter a major derivatives player. Top derivatives expert Satyajit Das, who has advised on every major international financial bankruptcy since the mid-1990s, described how messy the resolution of Lehman Brothers’ derivatives was, and for reasons that were intrinsic to its business model, not just the unplanned bankruptcy filing. American regulators refuse to challenge the financial-services industry’s claim that derivatives are used primarily for legitimate hedging and arbitrage. In truth, as the 2009 report by the U.K.’s FSA concluded, derivatives trading is mainly used for speculation, meaning creating risk and leverage.

Today U.S. banks are loading up on derivatives trading again. But until U.S. regulators come to conclusions about Wall Street’s practices that are similar to those of the U.K. and other European regulators, there’s ample reason to wonder whether they will realize the dangers of these untested living wills before the next crisis hits. The grim truth is that no one in the U.S. government is seriously considering an alternative solution to this problem. That spells trouble the next time Wall Street threatens to blow up the economy.