How the Bank Breakup Debate Will Play Out

WASHINGTON — At least half of the American public supports it, key voices on both sides of the political spectrum have embraced it and some top regulators think it's a good idea.

Make no mistake, the drive to break up the big banks continues to gain momentum — and we may be rapidly reaching a tipping point.

There are many reasons for how it came to this, including — but not limited to -- the bailouts of 2008, massive screw-ups in servicing mortgages, multimillion-dollar executive pay and a string of scandals such as Libor and the London Whale. Arguably the biggest one is that the public, still angry about the financial crisis, has yet to see anyone punished for it. Instead, they've heard Attorney General Eric Holder say some banks are too big to prosecute.

Demands for action — even if proponents don't agree on what that should be — are near a fever pitch.

It is hard to predict whether reform advocates will gain enough support to pass legislation, what regulators might do on their own or if big banks can ride out the storm relatively unscathed.

Following are the three most likely scenarios for how the debate plays out:

Scenario #1 — The Safe Bet
In politics, the easy money is always on the inability of Congress to pass legislation. The system was designed to make it difficult to move bills, and one that would fundamentally reshape the banking sector (again) faces more challenges than most.

Indeed, a bill along the lines of what Sens. Sherrod Brown, D-Ohio, and David Vitter, R-La., are offering, which would effectively break up the banks, would have to overcome resistance from the White House and the top leadership of both political parties.

Lobbyists said Friday that the bill's chances are weak. Although conservatives like Vitter and columnist George Will support the idea of breaking up the banks, many Republicans are likely to be swayed by anti-competitive concerns that such legislation would only make foreign institutions more powerful.

Meanwhile, the Obama administration — Holder's comments not withstanding — continues to argue that Dodd-Frank solved the problem of "too big to fail," making further legislation moot. While Brown and potentially Sen. Elizabeth Warren, D-Mass., two liberals, might be willing to go against the White House, not all Democrats will be.

Given enough time, the firestorm over "too big to fail" and "too big to jail" may die down again as other, more pressing issues arise.

Scenario #2 — The Unexpected Catalyst
Still, nearly everyone involved in the debate — regulators, lawmakers and the banks themselves — acknowledge the possibility that another scandal could further inflame passions and provide enough populist support to buck the White House and top Republicans.

To that end, Vitter and Brown have positioned themselves well, following the pattern of other lawmakers who managed to quickly transform once-radical ideas into law after a crisis. The financial industry, too, has a habit of underestimating how fast its once-solid positions can collapse.

In March 2001, American Banker declared anti-money laundering legislation — which would have placed a host of new requirements on banks — effectively dead for the year. But the bill became law seven months later, rolled up into the USA Patriot Act following the 9/11 attacks.

Sarbanes-Oxley requirements quickly followed the collapse of Enron and WorldCom, while the Consumer Financial Protection Bureau — an idea dismissed by bank lobbyists when Warren first suggested it in 2007 — became part of the 2010 Dodd-Frank law.

Another scandal may be all it takes for lawmakers to embrace the legislation from Brown and Vitter or float an alternative.

As if to prove how much the situation is shifting, the Senate approved a budget amendment late Friday that would require banks with more than $500 billion of assets to be taxed for any benefits they receive for being considered "too big to fail." The amendment is unlikely to survive in the long run, but it demonstrates that the tide is turning — and it will not take much to push it over the edge.

Scenario #3 — The Stealth Breakup
Federal Reserve Board Chairman Ben Bernanke made it very clear last week that regulators are focused on ending "too big to fail" and will not stop until it is gone for good.

After listing all the steps regulators are taking already — including higher capital standards, greater liquidity requirements and new "living wills" that detail how a firm could be unwound — Bernanke said if those failed, regulators would pursue other options.

"If we don't achieve the goal, I think, we'll have to do additional steps," he said. "It's not something we can just forget about."

Bankers got the message. Many already feel like regulators are squeezing them to death, burying them under an avalanche of never-ending regulations and compliance mandates. The CFPB alone has announced plans to examine credit card practices, banks' relationships with universities and oversight of auto dealer partnerships.

While the world focuses on the fate of legislation, regulators may slowly be forcing the very outcome that Brown and Vitter are seeking.

"I just think they will make it so damn hard, burdensome and expensive to be big, eventually some may decide it's not worth it," said one industry source, who spoke on condition of anonymity.

The public battle over "too big to fail" may even be helping regulators' private fight. As lawmakers continue to beat the drum for more punitive actions against the largest institutions, it makes it harder for bankers to push back, both legislatively and on the regulatory front. Stopping a bill may be relatively easy; but stopping regulators is much more difficult, particularly when the Dodd-Frank Act granted them sweeping new powers allowing them relative freedom to issue new mandates until "too big to fail" is a thing of the past.

Bankers might win the battle in Congress, yet lose the war.