Federal Reserve opposed as big bank savior by odd allies

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By Patrice Hill

An unusual alliance of conservatives and liberals is pushing to break up or downsize banks deemed "too big to fail," rather than create a new regulatory regime led by the Federal Reserve to try to keep them from getting into trouble again.

Public anger toward bailouts and the central bank's role in rescuing big institutions like American International Group Inc. and Bank of America Corp. are fueling growing opposition to the Fed-led oversight plan advocated by the Treasury Department and House Financial Services Committee Chairman Barney Frank, Massachusetts Democrat.

In Europe, regulators are moving to break up megabanks like ING Group, KBC and Lloyds that became government wards after last year's global financial meltdown. An increasing number of legislators, political activists and financial specialists in the U.S. want to move in the same direction for troubled institutions such as Citigroup and Bank of America.

Critics contend that these banks have learned little from the crisis and are milking the substantial funding advantage they have gained as a result of their government backing to go into risky ventures that pumped up their profits this year, but might be setting the stage for speculative bubbles and financial crises down the road. The Fed, they say, failed to see these problems before and would probably miss them again.

"The real culprits in this crisis were the large and mostly regulated banks in the United States and Europe. The size and extreme risk-taking by these institutions were among the key factors behind the depth of the crisis," said Nariman Behravesh, chief economist at IHS Global Insight.

"Unfortunately, the problem has become worse. Consolidation through distressed mergers and acquisitions in the wake of the events a year ago has made the concentration in the banking industry even greater," he said, "setting the stage for future banking crises if appropriate steps are not taken to either break up the large banks or to regulate them even more tightly."

Peter Schiff, president of Euro Pacific Capital and a Republican economic adviser, questioned whether it is desirable to allow banks to become too big to fail in the first place and then try to rein them in through regulation.

"If the government did not provide these bailouts or guarantees, then the market itself would ensure such organizations did not grow beyond their ability to attract capital," he said. "It is only when fear is overcome by government guarantees that systemic risks can arise."

While the Fed has sought recently to burnish its regulatory credentials by showing that it can be tough on big banks, proposing for the first time to regulate executive pay at the 28 largest firms, many legislators and analysts point out the Fed already had authority to regulate Citigroup Inc., Bank of America and other giant banks, but failed to foresee problems or take pre-emptive action while the crisis was developing.

Critics say the Fed may be too conflicted to crack down on big banks, since the Fed's 12 reserve bank presidents are elected by top bank executives who typically sit on the reserve banks' boards of directors. Before he went to Treasury, Secretary Timothy F. Geithner himself was selected by top New York banks like Citigroup and JPMorgan Chase & Co. to fill the critical post of New York bank president, the Fed official who interacts most closely with the big banks and Wall Street markets and who arranges most of the bailouts.