Should 'Too Big to Fail' Be Done Away With?

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A new bill moving through the Senate aims at restricting big banks' ability to risk on the taxpayers' dime.

At least that's what the bill's sponsors say. Senators Sherrod Brown (D-OH) and David Vitter (R-LA) have proposed that large banks – those with more than $500 billion in assets – be required to maintain capital equal to 15% of their assets at all times. If a bank has between $50 and $500 billion in assets it would have to maintain capital reserves of at least 8% of assets. The act is designed to ensure that such banks would never again need taxpayer bailouts after losses like the those during the recent financial crisis.

The big banks are, of course, screaming like stuck pigs. Industry groups are saying that new, voluntary controls that were put in place after the collapse already provide a guarantee and that legislation isn't necessary. Senator Brown has stated that if the large banks don't want to be governed by the bill they can reduce their assets until they are no longer regulated by it. Unsurprisingly, the industry doesn't find that statement comforting. The idea of restricting the amount of money that banks can lend – and therefore raising interest rates marginally for available lending – is enough to anger them.

Truly too big?

The act is broadly written, but in the end it comes down to just a few banks that have earned the ire of the taxpayers – and therefore Brown and Vitter.

JP Morgan Chase (NYSE: JPM) is one. Five years after the collapse and Chase is now insisting that the company didn't need a bailout back in 2008 and 2009. Still, rock star CEO Jamie Dimon's firm did accept both loans and TARP money during that time after risky loan losses placed the bank on shaky ground. Last year's enormous trading loss didn't make the case that the bank was behaving better. Still, there's solid share growth of 57% since last June and 2012 net profit of 21.94%.

Bank of America (NYSE: BAC) is a shakier bank than JPM. Not that it's in danger, really. But it didn't come out of the banking crisis in near as good shape. The bank took more than $40 billion through TARP and received guarantees that the government would help with $119 billion in potential losses on bad loans the firm made. Toss in the ongoing troubles with the acquisition of Countrywide and 2010 accusations of fraud in how it handled some muni bonds and it's been rough. Still, even through that, the bank has seen solid profitability and share growth. While only seeing a net margin of 5.03% in 2012, shares still grew 47.25% over the last twelve months. I'd take Chase before Bank of America, sure, but I wouldn't turn away from it either.

Maybe a little less big

Goldman Sachs (NYSE: GS) is a less traditional bank that could be impacted. Not so much a bank for the public, Goldman is more focused on investment banking than providing home loans and checking. Still, Brown and Vitter's legislation also seeks to control how large banks can account for investments and derivatives, and that could cramp Goldman's style and reduce its ability to make money. For investors, Goldman came through the bad times well with significant government help. But now it's profitable – 17.94% in 2012 – and the shares grew 28.01% in the last year.

Wells Fargo (NYSE: WFC) is one people know but not in the eye of the storm. By market cap, Wells Fargo is the largest bank in the US, coming in at $197.48 billion. That didn't stop Wells Fargo from needing $25 billion or more in help during the late unpleasantness, though. The bank took $25 billion worth of stabilization money in 2008 but redeemed it by the end of 2009. More than most, Wells Fargo came through the crisis well. Still, shares recently haven't been performing as well as some others. With a value growth of only 13.15% over the last year, it's actually underperformed the S&P even though net profit has been 22.50%.

Coping with it all

There are many hurdles for Brown-Vitter to overcome before it can become law. Opposition pops up from other legislators who think existing law – Dodd-Frank isn't fully implemented yet – can take care of the issue. Others seem to think that federal regulators can raise the needed capital requirements. Still, this is an issue that isn't going away – it's just too juicy a political target for politicians to shoot at. Best guess is that, even if the bill makes it through congress, it'll be watered down and limit some bank lending and investment types. That'll have a marginal effect on bank profits and activities. It should be enough to put some limit on investors' willingness to buy bank shares, but not enough to crash them.

Good luck!

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Nate Wooley has no position in any stocks mentioned. The Motley Fool recommends Goldman Sachs and Wells Fargo. The Motley Fool owns shares of Bank of America, JPMorgan Chase & Co., and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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