WASHINGTON -- The nation's four biggest banks can grow even bigger, with the potential to add at least another trillion dollars onto their balance sheets before they even reach the limits imposed by the Obama administration, according to an administration study released Tuesday.
Dodd-Frank, the 2010 law overhauling financial regulations, calls for regulators to impose a ten percent cap on individual financial firms' liabilities relative to the entire system. The rule is intended to prevent lenders from becoming so large that their collapse would threaten the health of the broader financial system.
Firms that hit that cap are not supposed to be able to grow through mergers or acquisitions, and banks that wish to get that big by gobbling up a competitor shouldn't be allowed to.
But the report, issued by the council of regulators that is supposed to keep watch for breakdowns in the financial system, calculates the formula in such a way that it leaves the largest U.S. lenders with plenty of room to grow. For example, JPMorgan Chase, the nation's second-biggest bank by assets, can merge with U.S. Bancorp, the 10th-biggest lender, and still fall comfortably under the limit.
"I said the banks won," said Simon Johnson, a former chief economist at the International Monetary Fund who now teaches at the M.I.T. Sloan School of Management and is a HuffPost contributing business editor. "It just tells you what the Treasury wants, and what they're telling you is they're going to cook it to let these banks expand."
Treasury Secretary Timothy Geithner heads the Financial Stability Oversight Council, which produced the study and accompanying recommendations. They're intended to guide regulators as they craft the rules that will attempt to restrain the growing concentration in the nation's financial system.
The big four banks, which collectively hold about $7.7 trillion in assets, or just about half of the entire banking system, originate and service roughly three out of every five home mortgages; hold about 35 percent of all deposits; and control about 44 percent of all credit card purchases, according to the council.
Just nine years ago, it took 15 banks to control half of the assets in the nation's banking system, according to the Federal Reserve.
In its study, the council said that limiting concentration will make the financial system more stable, efficient and competitive, and reduce implicit subsidy large firms receive when the market perceives them as too big to fail.
"Over the long run," the study states, "the concentration limit can be expected to enhance the competitiveness of U.S. financial markets by preventing the increased dominance of those markets by a very small number of firms."
It's unclear which firms will actually be limited by it, though.
Using the study's calculations, JPMorgan, Citigroup and Wells Fargo -- the second-, third- and fourth-largest U.S. banks -- could all acquire huge lenders like U.S. Bancorp, PNC Financial Services, Capital One Financial, and SunTrust Banks, the 10th-, 11th-, 13th- and 15-biggest banks.
Even Bank of America, which comes closest to the 10 percent ratio at 9.2 percent, could acquire a firm like Fifth Third Bancorp, one of the biggest lenders in the Midwest.
The reason why JPMorgan, Citigroup and others don't yet meet the 10 percent threshold is because of the way their liabilities are calculated.
Rather than taking their assets and deducting their capital, the formula calls for regulators to compensate for the relative riskiness of those assets, called risk-weighting. For example, because Treasuries are judged to be safe, they have a low risk-weighting. Complex financial instruments like certain derivatives, though, have a higher risk-weighting.
Bank of America has $2.34 trillion in assets, according to the most recent quarterly data filed with the Federal Reserve. But its risk-weighted assets total just $1.48 trillion, or 37 percent lower.
And big banks could get even bigger.
The council has the authority to designate certain financial firms that aren't banks as systemically important, meaning their failure could pose a risk to the entire financial system. For example, AIG would have been one such firm, regulators say.
Once the liabilities of these firms are added in, the pool of assets the banks would be judged by grows larger. According to the study, JPMorgan has about 7.1 percent of the system's liabilities. Once AIG-like firms are added, JPMorgan's ratio could shrink, enabling the lender to acquire its slightly smaller competitors.
"When you're in charge of writing the rules you get what you want," said Johnson, who's been critical of the administration's approach to ending Too Big To Fail. "This is what Treasury wants, and they want to give the bankers everything."
Johnson is among a group of finance experts who's advocated for the break-up of the nation's largest lenders. Others include Thomas Hoenig, president of the Federal Reserve Bank of Kansas City; James Bullard, president of the St. Louis Fed; and Richard Fisher, president of the Dallas Fed.
Reached after normal business hours, a Treasury Department spokesman declined to comment.
A measure that would have forced the country's financial behemoths to shrink failed in the Senate last year. Instead, the administration pushed for this concentration limit.
But while size is important, it's not the only factor, said John H. Cochrane, a finance professor at the University of Chicago Booth School of Business.
To Cochrane, size and other risk factors could be offset if banks simply held more capital to guard against losses. Banks typically have about $1 in capital for every $10 they lend out or invest. For the biggest banks, it's usually just $0.50.
"Even with 10 percent of the system's assets, with their extreme leverage, that sounds pretty dangerous to me," Cochrane said. "Banks need lots more capital -- way more than they have now."
The council's study confidently says that over time megabanks will be constricted from expanding through mergers and acquisitions. And once the final rules are written, regulators could take a tougher line.
For now, the limits don't apply to firms like JPMorgan Chase.