This is a dangerous combination for the industry, yet it is not being handled well.  Just look at the current strategy of the American Bankers’ Association.

Edward L. Yingling is justifiably proud of his organization’s postion as one of the country’s most powerful lobbies. 

His testimony to Congress on the potential new Consumer Financial Protection Agency plainly shows where his group stands.  The most revealing quote, highlighted in the ABA’s own press release, reads:

“It is now widely understood that the current economic situation originated primarily in the largely unregulated non-bank sector,” he said. “Banks watched as mortgage brokers and others made loans to consumers that a good banker just would not make and they now face the prospect of another burdensome layer of regulation aimed primarily at their less-regulated or unregulated competitors. It is simply unfair to inflict another burden on these banks that had nothing to do with the problems that were created.”

The premise here is false.  If major banks had really not been involved in the mortgage fiasco, we would not have had to roughly double our national debt-to-GDP in order to save the US and world economy.

Within the banking community, and presumably within the ABA’s membership, there is serious tension.  The small banks feel – overall with some justification – that the essence of the recent problem was not about them.  But they can’t bring themselves to suggest publicly that the economic and political power of the largest banks should be curtailed.

Small banks have always had clout in the American political system, particularly when they work through the Senate.  But we have not always had our current kind of crisis.  The executives of these banks lived comfortably in the 1950s and 1960s; their kind of banking was boring, stable, and nicely remunerated.

It is the changing nature and power of the largest financial institutions – banks of various kinds – that has damaged our system since the 1980s; the rise in financial services compensation is part symptom and part pathogen.  Big banks present the major risk going forward – to both the economy in general and to smaller banks in particular.

Most banks are "small enough to fail" (seven closed yesterday).  It is absolutely not in their interest to have some banks that are perceived to be "too big to fail" and to ever re-run any version of the last two years.

The ABA should be discussing and addressing this issue.  Instead, it is making all banks unpopular by opposing sensible legislation aimed at protecting consumers – look at the public relations context provided, for example, by Citi’s recent move on credit cards. 

The ABA’s leadership needs to quickly rethink its approach.

By Simon Johnson