The Path to 'Too Big to Fail'

To eliminate voter wrath over too-big-to-fail—while satisfying customers—we might eliminate bank holding companies and encourage well-capitalized banks with traded shares, subject to market discipline, through double liability, without geographic restrictions.

President-elect Donald Trump's team has voiced concerns about large banks getting larger, community banks disappearing and the ubiquitous too-big-to-fail problem. While well-capitalized banks subject to market discipline, rather than holding companies, would address these concerns, the underlying problems have been a long time in the making.

For much of U.S. history, laws and regulations made banks too small and prone to frequent crises. Banks were subject to market discipline after the National Bank Act of 1864, but that was undermined starting with the Federal Reserve Act of 1913. More recently, the Riegle-Neal Act of 1994, the Gramm-Leach Bliley Act of 1999 and the 2010 Dodd-Frank Act have encouraged more concentrated banking activity through holding companies rather than banks. Now we have holding companies without market discipline.

A 1987 study observed the roots of the problem lie in the Constitution, which prohibits states from issuing their own currencies. State governments instead found ways to raise revenues by chartering and taxing banks. Since states couldn't tax out-of-state banks, states prohibited interstate banking and often prohibited branch banking to increase charters and chartering revenue.

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