20-BAXTER (DO NOT DELETE) 1/7/2014 2:43 PM GÖTTERDÄMMERUNG BY LAWRENCE G. BAXTER∗ In his panel remarks on the future direction of financial regulation after the 2012 elections, Lawrence Baxter argues that the age of large banks and “too big to fail” is destined to come to an end, but not through the traditional avenue of governmental oversight. Baxter starts by detailing the warning signs that illuminate the unsustainable nature of the current financial model and moves to a discussion on the deficiencies of modern banking regulations. Some hope for an end to giant banking behemoths, Baxter finally posits, lies in stricter market discipline and a realization that smaller, less-complex banks provide returns that larger banks simply cannot match. It follows that free-market principles will likely do more to reign in the size of banks than regulation. My eight-year-old son is named after an ancient Irish king. He and I enjoy imagining the great adventures and heroism of ancient and SciFi mythology—Lord of the Rings, Star Wars, King Arthur and the Knights of the Roundtable, and the Ring of the Niberlungen. We like to celebrate his diverse European ancestry, from which so many of these legends are descended. One of his ancestral names is Volker. So with particular delight—and not without some little alarm on his part—we discovered that he can now trace his ancestry into the swirling mists of such mythical characters as Volker the Strong, one of Siegfried’s dragon slayers. Those familiar with Wagner’s cycle of four operas will understand, therefore, why, when I think of the future of big banking, I am drawn to the name of the last of those four operas, entitled Götterdämmerung, or Twilight of the Gods. Various developments suggest to me that the era of banking behemoths may be drawing to a close. The long running battle over whether the banks are “too big to fail,” “too big to manage,” “too complex to regulate,” and “too big to jail” has not receded. Far from it, ∗ William B. McGuire Professor of the Practice of Law, Duke University School of Law. Apart from a few selected updates in the footnotes, these comments are current as of the date of the Panel (Feb. 8, 2013). 20-BAXTER (DO NOT DELETE) 1/7/2014 2:43 PM 92 NORTH CAROLINA BANKING INSTITUTE [Vol. 18 the debate has marshaled powerful and well-informed individuals on both sides of the issues and on both sides of the Atlantic (and in THE 1 ATLANTIC! ). It is not a debate that will be settled soon, for there is a complicated case to be made on both sides.2 Nevertheless, there also appear to be signs that might portend some resolution and a slow twilight of the era of large universal banking. I am hopeful that the most important of these indications is coming from the markets themselves. I. THE WARNING SIGNS The full costs incurred by the large banks in the run-up to the Crisis are now becoming evident as one scandal after another emerges. Major banks (Deutsche and Barclays) are charged with having concealed their financial conditions in 2008 to avoid government intervention.3 News of huge penalties for improper behavior far more widespread than the occasional rogue trader—rate rigging, market manipulation, facilitating money laundering, and tax evasion being the 4 most prominent examples—are almost a daily event. Big banks have 1. See Frank Partnoy & Jesse Eisinger, What’s Inside America’s Banks?, THE ATLANTIC, Jan./Feb. 2013, available at http://www.theatlantic.com/magazine/archive/2013/01/whats-inside-americas- banks/309196/. 2. Lawrence G. Baxter, Betting Big: Value, Caution and Accountability in an Era of Large Banks and Complex Finance, 31 REV. BANKING & FIN. L. 765 (2012). 3. See, e.g., David Jolly, German Authorities Are Said to Investigate Deutsche Bank, N.Y. TIMES DEALBOOK (Apr. 4, 2013, 6:18 AM), available at http://dealbook.nytimes.com/2013/04/04/german-authorities-are-said-to-investigate- deutsche-bank/ (Deutsche Bank); Tom Braithwaite, Kara Scannell & Michael Mackenzie, Deutsche Hid Up To $12 Billion Losses, Say Staff, FIN. TIMES Dec. 5, 2012, available at http://www.ft.com/intl/cms/s/0/f03eb1d6-3efd-11e2-a095-00144feabdc0.html; Daniel Schäfer & Caroline Binham, Barclays in Qatar Loan Probe, FIN. TIMES, Jan. 31, 2013, available at http://www.ft.com/intl/cms/s/0/47d412ce-6bd1-11e2-a700- 00144feab49a.html#axzz2JZ8zTwBF (investigation into whether Barclays disguised a loan to Qatar in order to facilitate the latter’s equity investment in Barclays for the purpose of disguising Barclays’ capital position). 4. See, e.g., The LIBOR Scandal: The Rotten Heart of Finance, THE ECONOMIST, July 7, 2012, available at http://www.economist.com/node/21558281; Andrew Harris & Joe Richter, Goldman Sachs, London Exchange Sued Over Aluminum Supply, BLOOMBERG, Aug. 3, 2013, http://www.bloomberg.com/news/2013-08-02/goldman-sachs-london- exchange-sued-over-aluminum-supply-1-.html; Carrick Mollencamp et al., Special Report: Documents Allege HSBC Money-Laundering Lapses, REUTERS, May 3, 2012, available at http://www.reuters.com/article/2012/05/03/us-hsbcusa-probes-idUSBRE8420FX20120503; Robert W. Wood, FATCA Cliff: Tax Evasion Guilty Plea and Death for Oldest Swiss Bank, FORBES, Jan. 3, 2013, available at http://www.forbes.com/sites/robertwood/2013/01/03/global-banking-cliff-fatca-irs-guilty- plea-and-death-for-oldest-swiss-bank/. 20-BAXTER (DO NOT DELETE) 1/7/2014 2:43 PM 2013] GÖTTERDÄMMERUNG 93 paid billions of dollars in quasi-criminal penalties and lawsuit settlements. Even after reaching these settlements, the banks still have not realized the end of their liabilities: big banks still face, for example, continuing large class-action suits related to the foreclosure mess and the fallout from Libor interest rate rigging.5 Perhaps most importantly, more concrete calculations for assessing the degree of public subsidy large banks enjoy have been published and are being used in congressional hearings with powerful effect.6 Although the industry and even an undersecretary at Treasury have denied that such subsidies exist or are significant,7 their reasoning has been either nonexistent or unpersuasive. A combination of factors, particularly financial (to be addressed more fully below), makes for difficult times for large financial institutions. Even as bankers profess confidence in their ability to weather the storms, a number of possibilities could precipitate the sudden collapse of one or more big banks.8 As we have seen, that supposed paragon of risk management, JP Morgan Chase & Co., found itself in choppy waters as a result of aggressive trading activity by its 9 “London Whale” group in London. This has left many wondering what 5. See, e.g., Consent Judgment, United States of America v. Bank of America Corp., Case 1:12-cv-00361-RMC (D.D.C. Apr. 5, 2012) (national foreclosure settlement); Complaint, Adams v. Bank of America Corp., Case 12-cv-07461-UA (S.D.N.Y. Oct. 4, 2012) (LIBOR class action). 6. See, e.g., Kenichi Ueda and Beatrice Weder di Mauro, Quantifying Structural Subsidy Values for Systemically Important Financial Institutions, 37 J. BANKING & FIN. 3830 (2013) (estimating the structural value of government subsidy by exploiting expectations of state support embedded in credit ratings). 7. Mary John Miller, Under Secretary of the Treasury, Remarks at the Hyman P. Minsky Conference (Apr. 18, 2013) (transcript available at http://graphics8.nytimes.com/packages/pdf/business/Mary-Miller-speech.pdf). 8. The political consequences of such an event is acknowledged by one CEO opposed to large bank breakups: the CEO of Zions Bancorp recently observed that the country’s biggest banks are “one major misstep” away from being broken up. See Maria Aspan, Big Banks ‘One Major Misstep’ Away from Breakup: Zions CEO, AM. BANKER, Mar. 14, 2013, http://www.americanbanker.com/issues/178_51/big-banks-one-major-misstep-away-from- breakup-1057552-1.html. 9. See, e.g., Dominic Rushe & Jill Treanor, US Prosecutors Charge Two JP Morgan Traders over ‘London Whale’ Incident, THE GUARDIAN, Aug. 14, 2013, http://www.theguardian.com/business/2013/aug/14/us-prosecutors-jpmorgan-traders- london-whale; see also HOMELAND SEC. & GOVERNMENTAL AFFAIRS PERMANENT SUBCOMM. ON INVESTIGATIONS, REPORT: JPMORGAN CHASE WHALE TRADES: A CASE HISTORY OF DERIVATIVES RISKS AND ABUSES (MAR. 14, 2013), available at http://www.hsgac.senate.gov/download/report-jpmorgan-chase-whale-trades-a-case-history- of-derivatives-risks-and-abuses-march-15-2013. 20-BAXTER (DO NOT DELETE) 1/7/2014 2:43 PM 94 NORTH CAROLINA BANKING INSTITUTE [Vol. 18 might have happened to less tightly managed institutions in similar circumstances. It is not surprising, therefore, that observers are asking whether we can safely assume that large modern banks have become too complex to manage (and regulate). The late John Medlin, then-CEO of Wachovia, once cautioned me: “you never see the lightning that strikes you.”10 The sheet lightning on the horizon, however, is certainly visible, and I would suggest that a deadly bolt from the blue may well come from the increasingly complex web of technology on which modern banking now relies so heavily. The same technology that has made so real the virtual world of global finance, and levels of service, scale, and risk management undreamt of only three decades ago, also carries with it great and often unexpected dangers.11 Last year the subsidiary of a major British bank, The Royal Bank of Scotland, lost its ability to service customers for a lengthy period of time—so much so that its CEO had to forego a large portion of his compensation for the year.12 This outage was the result of problems in implementing a software upgrade.