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U.S. Treasury says Wall Street reform won't hurt small banks

File: A Bank of America branch is seen in Times Square October 19, 2010 in New York City.
File: A Bank of America branch is seen in Times Square October 19, 2010 in New York City.
Mario Tama/Getty Images

Financial regulation of Wall Street matters in Washington. The U.S. Treasury thinks so and has begun to blog about why. Yes, blog. In its most recent post, the Treasury debunks the idea that bank reform is somehow bad for small banks:

Myth #1: Wall Street Reform Hurts Small Banks


This claim is particularly dubious given strong support for enactment of the Dodd-Frank Act by the Independent Community Bankers of America.  Wall Street Reform helps level the playing field between large banks and small ones, helping to eliminate distortions that previously favored the biggest banks that held the most risk.

The operative concept here is risk. It isn't small banks that pose systemic risk to the banking system — it's the too-big-to-fail banks that ignored prudent risk models in the lead-up to the financial crisis. Robert G. Wilmers — a banking executive who runs M&T Bank, one of the few large banks that more or less sailed throught the financial crisis — provides a very succinct take on the problem at Bloomberg:

[R]isk is greatly magnified by the new way in which the major banks, those deemed too big to fail, are doing business today. The largest and most profitable bank holding companies have moved away from traditional lending and come to rely on speculative trading in all types of securities, derivatives, credit default swaps, mortgage-backed securities and other, even more complex and exotic financial instruments — many of them associated with high leverage.

Wall Street reform wants to restrict big banks' ability to engage in such speculative, risky leverage. It's really the leverage — the way that banks borrow against assets to increase their trading returns — that's the problem. If you don't get the risk-management right, or if the value of the underlying assets collapses as it did when the housing bubble burst, seeming unsinkable big banks can then pull a Titanic and need the lender of last resort, the U.S. taxpayer, to prevent them from sinking.

Small banks can't play at this game — they don't have the assets to engage in harrowing speculation. But they can lose business if the big banks operate under more favorable terms, mainly by pursuing outsized scale in order to drive down their own capital costs. Money costs them less, so they can push small lenders out of their traditional, relatively low-risk businesses, such as home loans and business loans.

I know that might sound better to consumers, given that big banks may be able to pass along the "savings," but effectively it just concentrates lending, in monopoly fashion, in the hands of few giants. This is what the Treasury means by "distortions."

The Treasury is right on about this one. And it's good to see it blogging its views! Stay tuned for more...

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