Proposals to reform the financial industry purport to address the “Too Big to Fail” issue, but do not address the underlying problem of “TOO BIG”. We are preoccupied with “growth”, somehow a company not experiencing top line growth is viewed as a poor performer, regardless of how profitable (per share) the company might be. “Bigger is Better” is the mantra of the market. Organic growth is usually not powerful enough to satisfy the market, so mergers and acquisitions abound.

This has certainly been the case in the banking industry. Banks routinely gobble up each other, even though there is really no evidence that there are any scale economies that will benefit customers or shareholders. Egos drive growth, there are so many examples of poor acquisitions driven by the CEO’s desire to have “the biggest” (but not the best) bank.

The latest and greatest proposed reform of the financial system seems to set incentives in the wrong direction. Banks officially identified as too large to fail will be more attractive for investors, they will borrow at lower costs (an unfair competitive advantage) and they will get larger, posing more risks to depositors and investors or, at the bottom line, taxpayers who will be obligated to make sure that they don’t fail as the government promised. The costs of “size and growth” have been made so clear and the subsidies provided to larger institutions (who can actually permanently borrow federal funds at “0%, for example, while small institutions could never do this) have been exposed – big bank investors and creditors are protected, small ones extinguished. Small bank earnings are being heavily taxed by FDIC to pay for the sins of those hot, fast growing institutions. This is wrong-headed.

Regulatory failure was perhaps as much a fault of the individuals involved as were deficiencies in the institutional structure. They had the powers to do much more than they did but had the wrong perspective and experience. Look at the previous occupations of so many of the regulators! The “mindset” of many of these regulators blinds them to many risks, they have big wheeling dealing backgrounds, much skill in using their asymmetric information to make money in a competitive market. They only think “Wall Street”, ignore the 8000 smaller banks that serve America’s consumers and small businesses on Main Street. This is a weakness that needs to be overcome.