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Hillary Clinton's plan to tame big banks shows her at her wonkish best

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Hillary Clinton has often stood accused of pandering or shaping policy proposals for political purposes, but her proposals for improving regulation of the financial system show her doing exactly the opposite — tackling the issue of mega-bank risk in a thoughtful way that is likely to prove politically thankless.

Her idea — not exactly optimized for a 15-second television spot — is to "charge a graduated risk fee every year on the liabilities of banks with more than $50 billion in assets and other financial institutions that are designed by regulators for enhanced oversight," with fees scaled to be "higher for firms with greater amounts of debt and riskier, short-term forms of debt."

It's a mouthful. Banks will hate it. It doesn't feature a crowd-pleasing, populist applause line. And it's a pretty great idea.

Hillary Clinton's risk fee, explained

The problem Clinton is trying to address here is that when a big bank goes bankrupt, it creates huge problems for the broader economy. Because of that, governments have a tendency to prevent big banks from going bankrupt.

And because of that, big banks have a tendency to engage in a riskier pattern of business than you see from other kinds of companies. All companies spend money to make money, but banks finance a much larger share of their spending with borrowed money (as opposed to retained profits) than you see from non-banks. And many banks rely very heavily on short-term borrowing, and fund ongoing operations by counting on their ability to get new short-term loans tomorrow. Financing investments with debt magnifies profits when your bets pay off, but it also magnifies losses when they don't. Using short-term debt rather than long-term debt lets you pay lower interest rates, but also exposes you to the possibility of unexpectedly finding yourself unable to get the money you need in an emergency situation. Both tendencies magnify risk.

Clinton is proposing to clamp down on those risks by imposing a tax on bank debt.

That compensates the public for the financial cost of bailouts and the social cost of bank failures, while also creating new incentives for banks to manage their affairs in a less risky manner.

How would this work, exactly?

Inconveniently from the standpoint of the content production industry, Clinton doesn't spell out precise numbers for her fee, perhaps recognizing that in the real world this would all be subject to negotiation in Congress anyway.

But the key pillars are:

  • The fee would be assessed on banks with more than $50 billion in assets (34 banks fit the bill as of today, though two of them are very close to the line) as well as on a handful of other institutions that the government has already flagged for extra regulatory scrutiny.
  • The fee rate would be higher on short-term debt than on long-term debt.
  • The fee rate would be higher on banks with more debt in their financing structure.
  • FDIC-insured bank deposits would be exempt from the fee.

The upshot of all this would be to nudge the banking system toward institutions becoming either smaller or else more boring, because risky activity would be more profitable in a smaller institution than in a larger one. The result would be to push risk out of the kinds of institutions whose failure would be catastrophic, without impeding banks' ability to become big per se.

A plan for the wonks

On the one hand, large, powerful, well-financed banks are going to hate this plan. It is very squarely aimed at making their preferred way of doing business less profitable.

On the other hand, Clinton has also failed to embrace the populist call to "break up the big banks." She's not proposing to reinstate the old Glass-Steagall rule, and she's not proposing a hard cap on bank size. She's come up with something that's considerably more complicated and harder to characterize in a quick slogan.

It also happens to be a better idea.

Nothing that went wrong during the financial crisis happened because commercial banking and investment banking were both housed inside a single company. Nor was it the biggest banks, per se, that proved to be the most problematic. Clinton's plan is better targeted at the specific problem of risk plus size, and as a bonus would raise revenue for the federal government.

A fallback plan for executive action

Clinton also says she would "call on regulators to impose higher capital requirements if she determines that such a step is a necessary complement to the fee."

This rather anodyne remark contains the seeds of an alternate approach to accomplishing her basic objectives through executive action. Existing law gives regulators the authority to set limits on bank borrowing, and in recent years regulators have been setting these limits more strictly. Clinton is suggesting that she might recommend regulators get even stricter on top of her proposed new series of bank fees. That carries the clear implication that in the absence of new fees, regulators would definitely have to impose stricter borrowing regulations. And while the regulatory agencies with the relevant power are mostly independent agencies, a President Clinton would be appointing the people who run them.

Existing regulatory authority would not allow the executive branch to precisely replicate the fee structure Clinton is proposing (no revenue would be raised, for example), but it could certainly be used to produce comparable results.

This is just one element of a broader Clinton plan for Wall Street regulation, but it shows her at her wonkish best. She is addressing the core concern of populist bank bashers without being a slave to their preferred methods and slogans. And she's recognizing the importance of both an ideal-case legislative path forward and a more realistic path that involves the use of executive authority. And while the plan is unlikely to generate much positive attention (or, indeed, any attention) in the mainstream press, it just so happens to address a question of urgent importance to the economic welfare of everyone in the country.