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Dallas Fed's Fisher Rages Against TBTF, Says Only Way To Remove Systemic Risk Is Shrinking The Megabanks

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In a speech before the SW Graduate School of Banking, Dallas Fed's Richard Fisher comes out swinging, blasting his boss Ben Bernanke and his policy of globalized moral hazard: "Let me make my sentiments clear: It is my view that, by propping up
deeply troubled big banks, authorities have eroded market discipline in
the financial system. It is not difficult to see where this dynamic leads—to more pronounced financial cycles and repeated crises." And just in case listeners missed the point, he followed up: "Just this morning, the Washington Post summarized the impasse
that inevitably blocks treatment of the TBTF pathology. In an article
on preparation for this weekend’s Group of 20 talks on bank reform, it
was noted that “some” participants “remain hesitant to lean too hard on
banks they consider vital to their national economies.” This hesitancy only perpetuates the problem: The longer authorities
delay the process, the more engrained behemoth financial institutions
become; the more engrained they become, the less extricable they are.
And so the debilitating disease of TBTF spreads. What appears “vital”
becomes “viral” and grows ever more threatening to financial stability
and economic stability.
"

Fischer implicitly supports Ted Kaufman's proposal, which failed in the corrupt and Chris Dodd subservient Senate, that had proposed a very sensible size limitation on banks:

Some counter that even if all banks were made small or mid-size (or at least not TBTF), systemic threats—and thus the incentive for regulators to step in and save financial institutions—would not disappear. For instance, if a lot of small banks got into trouble simultaneously—or, as I like to say, forgot they had already been to the Ocean View Restaurant before and made the same bad bets at the same time—one might expect the central bank and regulators to protect bank creditors, extending TBTF protections once again. As the argument goes, breaking up big banks may be necessary but is possibly not sufficient—policymakers still must grapple with the possibility of many smaller banks getting into trouble at the same time, causing a “systemic” problem.

I consider this argument hollow for a few reasons.

First, even if this possibility turned out to be true, the threat of a loss from more isolated difficulties would mean creditors could reasonably expect losses in certain circumstances—a situation unlike TBTF.

Second, going by what we see today, there is considerable diversity in strategy and performance among banks that are not TBTF. Looking at commercial banks with assets under $10 billion, over 200 failed in the past few years, and as we have seen, failures in the hundreds make the news. Less appreciated, though, is the fact that while 200 banks failed, some 7,000 community banks did not. Banks that are not TBTF appear to have succumbed less to the herd-like mentality that brought their larger peers to their knees.

We saw similar diversity during the Texas banking crisis of the late 1980s. Small banks had diverse risk exposures. The most aggressive ones failed, while the more conservative did not.[11]

Some have also pointed to the Great Depression as a period when many small banks got into trouble at the same time. That situation seems less relevant to the policy questions we face today. Those failures were the result of a liquidity crisis that brought down both nonviable and viable banks. Such a liquidity crisis among small banks would be unlikely today, as we now have federal deposit insurance, which protects deposits for funding. And, I might add, the Federal Reserve has demonstrated quite effectively over the past two years that we not only have the capacity to deal with liquidity disruptions but also the ability to unwind emergency liquidity facilities when they are no longer needed.

The point is this: The arguments against shrinking the largest financial institutions are found wanting. And sufficient or not, ending the existence of TBTF institutions is certainly a necessary part of any regulatory reform effort that could succeed in creating a stable financial system. It is the most sound response of all. The dangers posed by institutions deemed TBTF far exceed any purported benefits. Their existence creates incentives that will eventually undermine financial stability. If we are to neutralize the problem, we must force these institutions to reduce their size.

I do not want to be naïve here. I am not suggesting that our banking system devolve into institutions like the Bailey Building and Loan Association in It’s a Wonderful Life. Large institutions have their virtues. They can offer an array of financial products and services that George Bailey could not. A globalized, interconnected marketplace needs large financial institutions. What it does not need, in my view, are a few gargantuan institutions capable of bringing down the very system they claim to serve.

Unfortunately, in preserving the dictatorial nature of the Federal Reserve system, Ben Bernanke will neither listen to Hoenig, who earlier said a rate hike to 1% by the end of the summer is critial, nor to Fisher, whose suggestion will destroy any hope of Bernanke's true employers can ever have of reaping the kinds of bonuses they are used to, and hope to extract from the middle class at least one more time before the ponzi house of cards collapses once and for all.

Full speech:

Richard
W. Fisher

Financial Reform or Financial Dementia?
Remarks at the SW Graduate School of Banking
53rd Annual Keynote Address and Banquet

Dallas, Texas
June 3, 2010

I
understand from Scott MacDonald that tonight is the 53rd annual keynote
address and banquet of the SW Graduate School of Banking—an impressive
anniversary, which reminds me of a story.

A
couple is deciding where to dine on their 10th wedding anniversary.
They settle on the Ocean View Restaurant because that is where the
beautiful, hard-bodied people go. On their 20th anniversary, they
discuss where to celebrate, and they agree again on the Ocean View
because the wines and the food are superb. For their 30th, they return
to the Ocean View once more, having agreed that, as they sit there in
silence, the view from the terrace is second to none. On their 40th
anniversary, they agree that the Ocean View is just right because it
has wheelchair access and an elevator to get them to the porch
overlooking the ocean. On their 50th, they want to do something truly
special to celebrate. So they decide to go to the Ocean View … because
they have never been there before.

Most
of you are bankers—many, graduates or future graduates of this fine
school. My message to you tonight is to remember where we have been. We
have collectively been to hell and back. Let’s not go there again.
Let’s remember that bankers should never succumb to what is trendy or
fashionable or convenient but should instead focus on what is
sustainable and in the interest of providing for the long-term good of
their customers.

You
gather tonight on the eve of a conference of key members of the House
of Representatives and the Senate of the United States seeking to agree
upon legislation to foster financial reform.[1]
This evening, I am going to discuss this reform initiative. I do so, as
always, speaking my own mind, making clear that I speak for nobody else
at the Fed (something that is usually patently clear). I do so as one
of only a few members of the Federal Open Market Committee who have
been practicing commercial bankers. And I do so in the belief that it
is always best to speak the truth to political convention.

In
their unicameral sessions, the House and Senate have cleared away a lot
of the underbrush of who does what to whom. As it now stands—due in
significant part to the efforts of Sen. Hutchison of Texas and her
colleague Sen. Klobuchar of Minnesota—my colleagues and I at the
Federal Reserve will have responsibility for regulating, in some
fashion, banking organizations across the spectrum, from community and
regional banks to money center banks to thrift holding companies. I
believe we are best suited for such responsibility. We have been battle
hardened by the crises of both the 1980s here in Texas and this most
recent episode, which threatened to bring the system of market
capitalism to the brink. Yet, at the same time, I have some concerns
about our ability to deal with the most vexing of the issues presented
by the recent crisis: the issue of institutions that are considered
“too big to fail” (or, if you prefer the acronym that has become
commonplace, TBTF).

The Not-So-Shadow System
It
has become popular to blame recent financial problems on the so-called
shadow banking system. This, however, is an obfuscation. The heavily
advertised distinction between commercial banks and the shadow banking
system is, in many ways, false.

Take,
for example, one of the most well-known and problematic phenomena of
the shadow banking world: structured investment vehicles, or SIVs.
Despite repeated claims to the contrary, SIVs were not distinct from
commercial banks. Many SIVs actually originated from the very core of
the commercial banking system—dominated in size by the largest
banks—where bank regulation was presumably the strongest. Make no
mistake: Big banks created SIVs. They supported SIVs with credit and
liquidity enhancements. They marketed and invested in SIVs. And once
the crisis hit, big banks were forced to bring SIVs onto their balance
sheets. In this way, the presumed distinction between the commercial
banking system and the so-called shadow banking system is false.

It
is also a widely held misperception that SIVs escaped regulatory
treatment. Regulators knew about them and even applied capital
requirements to them. Unfortunately, those regulatory requirements were
woefully inadequate. The favorable regulatory treatment granted to many
of these vehicles was, in many cases, what accounted for their
existence. The vehicles were created not so much for an economic
purpose, but rather to minimize regulatory capital requirements.

SIVs
and other programs sponsored by big banks were also exposed to runs. In
contrast to other members of the shadow banking system—like hedge
funds—SIVs had inadequate mechanisms in place to protect their
liquidity.

I do
not wish to single out SIVs. They are just one example of the excess to
which large institutions succumbed. We are well aware of the alphabet
soup of acronyms, including CDOs and CLOs, that contributed to the
crisis, along with an excessive degree of faith in the ability of
complex statistical models to mathematize risk taking.

Dealing with TBTF
Of
course, recent financial problems have not been limited to large
institutions and their opaque operations. As you in this room know all
too well, regional and community institutions have faced their own
difficulties, especially in the context of construction lending.
Smaller banks that have realized debilitating losses have failed. When
they got into deep trouble, regulators took them over and resolved them.

We
might have expected a similar treatment of big banks. But we would have
been wrong. Regulators have, for the most part, tiptoed around these
larger institutions. Despite the damage they did, failing big banks
were allowed to lumber on, with government support. It should come as
no surprise that the industry is unfortunately evolving toward larger
and larger bank size with financial resources concentrated in fewer and
fewer hands.

Based
on these considerations, coupled with studies suggesting severe limits
to economies of scale in banking, it seems that mostly as a result of
public policy—and not the competitive marketplace—ever larger banks
have come to dominate the financial landscape. And, absent fundamental
reform, they will continue to do so. As a result of public policy, big
banks have become indestructible. And as a result of public policy, the
industrial organization of banking is slanted toward bigness.

Big
banks that took on high risks and generated unsustainable losses
received a public benefit: TBTF support. As a result, more conservative
banks were denied the market share that would have been theirs if
mismanaged big banks had been allowed to go out of business. In
essence, conservative banks faced publicly backed competition.

Let
me make my sentiments clear: It is my view that, by propping up deeply
troubled big banks, authorities have eroded market discipline in the
financial system.

The
system has become slanted not only toward bigness but also high risk.
Consider regulators’ efforts to impose capital requirements on big
banks. Clearly, if the central bank and regulators view any losses to
big bank creditors as systemically disruptive, big bank debt will
effectively reign on high in the capital structure. Big banks would
love leverage even more, making regulatory attempts to mandate lower
leverage in boom times all the more difficult. In this manner, high
risk taking by big banks has been rewarded, and conservatism at smaller
institutions has been penalized. Indeed, large banks have been so bold
as to claim that the complex constructs used to avoid capital
requirements are just an example of the free market’s invisible hand at
work. Left unmentioned is the fact that the banking market is not at
all free when big banks are not free to fail.

It is not difficult to see where this dynamic leads—to more pronounced financial cycles and repeated crises.

This
is the threat that legislators are now attempting to address in the
financial reform bill. A widely noted feature of this legislative
effort is the fairly broad scope for regulatory discretion.

For instance, under the proposed legislationoff-site PDF,
systemically important companies are required to submit a “living
will.” According to the legislation, these firms are “to report
periodically to the [Fed’s] Board of Governors, the [Financial
Stability Oversight] Council, and the [FDIC] the plan of such company
for rapid and orderly resolution in the event of material financial
distress or failure.”[2]

If
the Board and FDIC find the plan deficient, the bill calls for the
company to resubmit an alternative approach within a set time frame.
Failure to resubmit the resolution plan could result in the imposition
of more stringent capital, leverage or liquidity requirements or
restrictions on growth and activities. Furthermore, the Board and FDIC,
in consultation with the council, may direct the firm “to divest
certain assets or operations identified by the Board of Governors and
the [FDIC], to facilitate an orderly resolution.”[3]

The
legislation also requires that a Credit Exposure Report be submitted
“periodically” on “the nature and extent to which the company has
credit exposure to other significant nonbank financial companies and
significant bank holding companies; and … the nature and extent to
which other significant nonbank financial companies and significant
bank holding companies have credit exposure to that company.”[4]

The
new Financial Stability Oversight Council is directed to “make
recommendations to the [Fed’s] Board of Governors concerning the
establishment of heightened prudential standards for risk-based
capital, leverage, liquidity, contingent capital, resolution plans and
credit exposure reports, concentration limits, enhanced public
disclosures, and overall risk management” for systemically important
institutions.[5]

The name of the game, here, is regulatory discretion.

There
are—as there always are—criticisms. Some feel, for instance, that while
regulators are being given more authority, they are also being given
ambiguous, if not conflicting, directives that would leave the specter
of TBTF lurking in the background. For instance, the bill states that
it seeks “to provide the necessary authority to liquidate failing
financial companies that pose a significant risk to the financial
stability of the United States in a manner that mitigates such risk and
minimizes moral hazard.”[6]
It also directs the FDIC to “ensure that the shareholders of a covered
financial company do not receive payment until after all other claims …
are fully paid.”[7]
However, the bill goes on to state that in the disposition of assets,
the FDIC shall “to the greatest extent practicable, conduct its
operations in a manner that … mitigates the potential for serious
adverse effects to the financial system.”[8]

Language that includes a desire
to minimize moral hazard—and directs the FDIC as receiver to consider
“the potential for serious adverse effects”—provides wiggle room to
perpetuate TBTF.

Criticisms
aside, this is the path our legislative powers have laid out for
dealing with the issue of TBTF. Regulators must now decide exactly how
they will travel down that path.

There
appear to be three major ways to navigate proposed policy making toward
big banks: (1) the regulate ’em camp, (2) the resolve ’em camp and (3)
the shrink ’em camp.

Let’s examine these one by one.

Regulate ’Em
First,
we have the “regulate ’em” camp. While it is certainly true that
ineffective regulation of systemically important institutions—like big
commercial banking companies—contributed to the crisis, I find it
highly unlikely that such institutions can be effectively regulated,
even after reform.

To
be blunt: Simple regulatory changes in most cases represent a too-late
attempt to catch up with the tricks of the regulated—the trickiest of
whom tend to be large. In the U.S. financial system, what passed as
“innovation” was in large part circumvention, as financial engineers
invented ways to get around the rules of the road. There is little
evidence that new regulations, involving capital and liquidity rules,
could ever contain the circumvention instinct.

The history of regulatory capital requirements is not a distinguished one:[9]

  • In
    1864, the National Bank Act set minimum capital requirements, but these
    attempts at quantifying capital adequacy were unsuccessful. Over the
    years, such efforts continued at both the state and federal level, but
    without much success.
  • By the
    1950s, it was concluded that static capital requirements could only
    interfere with the more comprehensive analyses required to obtain a
    complete picture of a bank’s ability to absorb losses.
  • In
    1981, the federal banking agencies responded to diminishing bank
    capital positions by introducing numerical capital requirements, as the
    judgment-based approach to capital regulation had proven insufficient.
    But before long, authorities felt the need to revise these new
    numerical requirements, as they failed to differentiate between banks
    according to risk and invited capital arbitrage.
  • In
    1988, the central banks of the G-10 adopted risk-based capital
    requirements, as embodied in the Basel Accord. It did not take long
    before the need for change was felt once again as the original accord
    proved a blunt instrument that did not differentiate properly among
    various risk types and allowed significant avenues for capital
    arbitrage, particularly through loan securitization.
  • In
    response, authorities began crafting Basel II. However, before it could
    be fully implemented, the risks taken through loan securitization blew
    up, producing the most severe financial crisis since the Great
    Depression.
  • And as we know all
    too well, even if Basel II had gone into full effect, it would not have
    contained risk effectively nor created a sufficient buffer against
    losses.
  • Thus, policymakers have been busily constructing what may be thought of as Basel III.

Regulatory
reform discussions portray the need to control systemic risk as a new
game in town—as if it were a new responsibility that need only be
assigned. This is not the case: Bank regulators have long viewed the
containment of systemic risk as a primary rationale for capital
requirements. The problem is that capital regulation has rarely been
truly successful.

Requiring
additional capital against risk sounds like a good idea but is
difficult to implement. What should count as capital? How does one
measure risk before an accident occurs? And how does one counteract the
strong impulse of the regulated to minimize required capital in highly
complex ways? History has shown these issues to be quite difficult.
While we do not have many examples of effective regulation of large,
complex banks operating in competitive markets, we have numerous
examples of regulatory failure with large, complex banks.

So, you might say I am a skeptic of regulation alone.

Resolve ’Em
In
my opinionated view, a traditional regulatory response—while
well-intentioned—cannot, by itself, fully address the threat of TBTF.
So we turn to the “resolve ’em” camp.

The
argument goes something like this: If deeply troubled large banks are
allowed to fail, the banking industry could evolve toward a
market-driven structure. During the recent crisis, regulators lamented
the lack of a formal resolution process for large and complex financial
organizations, claiming it reduced their options and tied their hands.
So it follows that a resolution regime whereby regulators can
economically resolve failed big banks might be the ticket. In this
case, there will be no more TBTF.

Unfortunately,
imposing creditor losses at a failing big bank, while simultaneously
avoiding market disruptions, involves more than a bit of sophistry.
Realistically, it would be difficult to accomplish both at the same
time. Based on experience, one of these goals will take precedence over
the other. And history shows which goal typically wins.

The
sad truth is that when the chips are down, regulators become reluctant
to put their money where their mouths are—or more precisely, they
become too eager to put their money where they said they would not.
Few, if any, policymakers have been willing to let large banking
organizations fail, thereby missing an opportunity to impose
significant losses on failed institutions’ creditors. We know from
intuition and experience that any financial institution deemed TBTF
will not be allowed to fail in the traditional sense. When such an
institution becomes troubled, its creditors are protected in the name
of market stability. The TBTF problem is exacerbated if the central
bank and regulators view wiping out big bank shareholders as too
disruptive, extending this measure of protection to ordinary equity
holders.

In the
recent crisis, authorities protected both—uninsured creditors and
shareholders of big banks. While uninsured creditors received the
greatest protection, regulators even partnered with existing
shareholders through the injection of public funds. This program
eventually spread to banks of all sizes, but its initial focus was the
very largest banks. True, many large-bank shareholders sustained severe
losses—but they were not zeroed out. They and their institutions have
lived to see another day.

Why
should we think the future could, realistically, be any
different—especially with even bigger banks that dominate the financial
landscape today?

A
credible big-bank resolution process that imposes creditor losses will
be difficult to enforce, especially when regulators are explicitly
directed to mitigate disruptions to the financial system, as they are
in the proposed reform bill. And there remain the technical problems of
resolution, such as the difficulty of quickly estimating a rate of
recovery on a large and complex banking organization and paying it out
to creditors. Countless issues like this remain unaddressed. For
instance, how would a resolution regime market assets of a failed big
bank? Major business lines presumably would be kept intact to preserve
value and maximize recovery. But if one large organization were simply
sold to another, the industry could become more concentrated than
before. That is exactly what happened during the crisis as large
failing firms were sold to other large firms.

All
of this ignores a still-greater problem: Even if an effective
resolution regime can be written down, chances are it might not be
used. There are myriad ways for regulators to forbear. Accounting
forbearance, for example, could artificially boost regulatory capital
levels at troubled big banks. Special liquidity facilities could
provide funding relief. In this and similar manners, crisis-related
events that might trigger the need for resolution could be avoided,
making resolution a moot issue. TBTF would continue, in any case.

Consider
the idea of limiting any and all financial support strictly to the
system as a whole, thus preventing any one firm from receiving
individual assistance. Many have argued such a restriction would
minimize the possibility of bank bailouts. Even under this restriction,
however, support for large institutions at the expense of smaller peers
could live on. If authorities wanted to support a big bank in trouble,
they would need only institute a systemwide program. Big banks could
then avail themselves of the program, even if nobody else needed it.
Systemwide programs are unfortunately a perfect back door through which
to channel big bank bailouts.

Or
consider the so-called living wills introduced in the financial reform
bill. These presumably might serve as a type of instruction manual or
roadmap for resolving a large failed bank. But, quite unfortunately,
large banking companies have organized themselves in ways that entail
significant spillovers to other financial firms and the economy,
thereby making a bailout, in many cases, the only credible choice for
policymakers. Legislators have attempted to work around this pitfall,
requiring changes to large banking companies whose wills are found
wanting—prior to a crisis. This could, if used properly, reduce to
tolerable levels the spillovers that would result from the imposition
of creditor losses. Regardless, even after requested changes have been
made, if these wills are still lacking, the associated firms will be
TBTF.

Again, in
my view, enhanced resolution regimes, by themselves, are not enough to
end TBTF. Even a combination of enhanced regulation and resolution
would likely be inadequate. The temptation to use regulatory discretion
to avoid disruptions is just too great.

Shrink ’Em
This
leaves us with only one way to get serious about TBTF—the “shrink ’em”
camp. Banks that are TBTF are simply TB—“too big.” We must cap their
size or break them up—in one way or another shrink them relative to the
size of the industry.

In
its latest version, the financial regulatory reform bill has left
regulators (specifically, the Board of Governors and the Federal
Deposit Insurance Corp.) with the authority to impose greater
restrictions on firms whose living wills are not credible. That
authority, as I mentioned previously, could include “[divesting]
certain assets or operations … to facilitate an orderly resolution.”[10]
I would argue that regulators should freely use this broad authority to
commit credibly to resolution with creditor losses by reducing big
banks’ size and interconnectedness.

(You
can see why my stance on TBTF hardly endears me to audiences on Wall
Street. I am given to quoting Winston Churchill in response. He said
that “in finance, everything that is agreeable is unsound and
everything that is sound is disagreeable.” It is most disagreeable to
the big bank, big money lobby to countenance restrictions on size, and
hence it is the perceived wisdom that this approach is disagreeable.
And yet it is perhaps the most sound approach of all those proffered.)

Some
counter that even if all banks were made small or mid-size (or at least
not TBTF), systemic threats—and thus the incentive for regulators to
step in and save financial institutions—would not disappear. For
instance, if a lot of small banks got into trouble simultaneously—or,
as I like to say, forgot they had already been to the Ocean View
Restaurant before and made the same bad bets at the same time—one might
expect the central bank and regulators to protect bank creditors,
extending TBTF protections once again. As the argument goes, breaking
up big banks may be necessary but is possibly not
sufficient—policymakers still must grapple with the possibility of many
smaller banks getting into trouble at the same time, causing a
“systemic” problem.

I consider this argument hollow for a few reasons.

First,
even if this possibility turned out to be true, the threat of a loss
from more isolated difficulties would mean creditors could reasonably
expect losses in certain circumstances—a situation unlike TBTF.

Second,
going by what we see today, there is considerable diversity in strategy
and performance among banks that are not TBTF. Looking at commercial
banks with assets under $10 billion, over 200 failed in the past few
years, and as we have seen, failures in the hundreds make the news.
Less appreciated, though, is the fact that while 200 banks failed, some
7,000 community banks did not. Banks that are not TBTF appear to have
succumbed less to the herd-like mentality that brought their larger
peers to their knees.

We
saw similar diversity during the Texas banking crisis of the late
1980s. Small banks had diverse risk exposures. The most aggressive ones
failed, while the more conservative did not.[11]

Some
have also pointed to the Great Depression as a period when many small
banks got into trouble at the same time. That situation seems less
relevant to the policy questions we face today. Those failures were the
result of a liquidity crisis that brought down both nonviable and
viable banks. Such a liquidity crisis among small banks would be
unlikely today, as we now have federal deposit insurance, which
protects deposits for funding. And, I might add, the Federal Reserve
has demonstrated quite effectively over the past two years that we not
only have the capacity to deal with liquidity disruptions but also the
ability to unwind emergency liquidity facilities when they are no
longer needed.

The
point is this: The arguments against shrinking the largest financial
institutions are found wanting. And sufficient or not, ending the
existence of TBTF institutions is certainly a necessary part of any
regulatory reform effort that could succeed in creating a stable
financial system. It is the most sound response of all. The dangers
posed by institutions deemed TBTF far exceed any purported benefits.
Their existence creates incentives that will eventually undermine
financial stability. If we are to neutralize the problem, we must force
these institutions to reduce their size.

I
do not want to be naïve here. I am not suggesting that our banking
system devolve into institutions like the Bailey Building and Loan
Association in It’s a Wonderful Life. Large institutions have
their virtues. They can offer an array of financial products and
services that George Bailey could not. A globalized, interconnected
marketplace needs large financial institutions. What it does not need,
in my view, are a few gargantuan institutions capable of bringing down
the very system they claim to serve.

Europe and TBTF
Of
course, we are not the only ones dealing with the monstrous challenges
of TBTF. Our friends across the Pond are also focused on the risks
posed by institutions that have grown dangerously large (called
“systemically important financial institutions,” or SIFIs). Despite
Europe’s longstanding accommodation of, and preference for, large
banking organizations in the universal banking model, the European
Central Bank has become fairly forthright about the problem.

Unfortunately,
in attempting to address TBTF, the European Union is falling into the
regulate ’em and resolve ’em camps, leaning toward capital regulation
and enhanced resolution regimes as a way to limit systemic risk. Given
Europe’s prevailing universal banking model, policymakers have so far
stayed well outside the shrink ’em camp.

But
even while policymakers in Europe debate ways to tackle TBTF, the risks
posed by big, interconnected banks are materializing once again, as the
adverse effect of rising sovereign credit risk on euro-area banks has
led to renewed concerns about systemic risk.

Moreover,
Europe’s extensive public support of the banking sector under TBTF
policy has left authorities with challenging questions about how to
disengage this support fully without disrupting the nascent financial
recovery. All these policy questions serve to illustrate the harsh
tradeoffs and intractable complexities arising from the public–private
intermingling entailed by TBTF.

Conclusion
For
our capitalist system to work properly, it is important that successful
risk taking be rewarded and equally important that unsuccessful risk
taking be penalized. Legislators have done their level best over the
past few months to, in effect, solidify this principle in our system.

That
said, the race is far from over. Regulators now must pick up the baton
and head for the finish line, using the authorities granted them in a
manner that will ensure the safety and soundness of our system in the
future. I would like to see us not waste this opportunity for true
reform.

Just this morning, the Washington Post
summarized the impasse that inevitably blocks treatment of the TBTF
pathology. In an article on preparation for this weekend’s Group of 20
talks on bank reform, it was noted that “some” participants “remain
hesitant to lean too hard on banks they consider vital to their
national economies.”[12]
This hesitancy only perpetuates the problem: The longer authorities
delay the process, the more engrained behemoth financial institutions
become; the more engrained they become, the less extricable they are.
And so the debilitating disease of TBTF spreads. What appears “vital”
becomes “viral” and grows ever more threatening to financial stability
and economic stability.

I
know the night is long, and I apologize for imposing the ponderous
thoughts of a central banker upon you at this late hour. But go back to
our aging couple and their fondness for the Ocean View Restaurant. In
September, we will celebrate the 26th anniversary of the first
announcement of the government’s TBTF policy. In September 1984, the
Comptroller of the Currency testified before Congress that the
government would not allow any of the nation’s 11 largest banks to
fail. The Comptroller did, however, stress the need to find a way to
deal with the potential failure of large institutions, and here we are
today having failed to do so.[13]
We can now keep kicking the can of TBTF down the road until dementia
sets in and the banking system is made rotten by a refusal to
acknowledge the pathology at the heart of the problem. Or we can use
the occasion of the recent financial crisis to deal with it
forthrightly while we are still vigorous and vital. I prefer the latter
approach.

About the Author

Richard W. Fisher is president and CEO of the Federal Reserve Bank of Dallas.

Notes

The views expressed by the author do not necessarily reflect official positions of the Federal Reserve System.

  1. As of the date of this speech, the tentative timeline shows the first open meeting scheduled for Wednesday, June 9.
  2. Sec. 165 of the Senate bill.
  3. Sec. 165 of the Senate bill.
  4. Sec. 165 of the Senate bill.
  5. Sec. 112 of the Senate bill.
  6. Sec. 204 of the Senate bill.
  7. Sec. 206 of the Senate bill.
  8. Sec. 210 of the Senate bill.
  9. For
    a brief history of capital regulation leading up to Basel II, see
    “Basel and the Evolution of Capital Regulation: Moving Forward, Looking
    Back,” Federal Deposit Insurance Corp., Jan. 14, 2003.
  10. Sec. 165 of the Senate bill.
  11. “Texas Banking Conditions: Managerial Versus Economic Factors,” by Jeffery W. Gunther, Financial Industry Studies, Federal Reserve Bank of Dallas, October 1989, pp. 1–18.
  12. “Geithner Urges Swift ‘Global Agreement’ on Financial Reforms to Support Recovery,” by Howard Schneider, Washington Post, June 3, 2010, p. A12.
  13. “U.S. Won’t Let 11 Biggest Banks in Nation Fail,” by Tim Carrington, Wall Street Journal, Sept. 20, 1984.
 

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Thu, 06/03/2010 - 22:15 | 393476 CB
CB's picture

If they'd been left to fail in the first place there'd be no need to talk about shrinking the damn things.

Thu, 06/03/2010 - 22:17 | 393483 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

+1.5 quadrillion

Thu, 06/03/2010 - 22:28 | 393516 Greater Fool
Greater Fool's picture

Indeed. We'd all be too busy waiting in bread lines to wonder about such trivia anyway.

Thu, 06/03/2010 - 22:43 | 393548 E pluribus unum
E pluribus unum's picture

Jamie Dimon - Is that you?

Thu, 06/03/2010 - 23:17 | 393621 Problem Is
Problem Is's picture

Say... didn't Neel "Down You Bitch" Kashkari officially start at PIMPCO about 6 weeks ago?

The same time Greater Fool got a pass from Tyler?

Hmmmmmm... Maybe it isn't Timmay's Uncle Jamie sock puppet after all...

Thu, 06/03/2010 - 23:30 | 393660 Greater Fool
Greater Fool's picture

Yes. I just awarded myself another couple million in bonuses for my Q1 performance and figured I'd spend a few minutes slumming.

See you in the Hamptons! Or not, sucker.

Fri, 06/04/2010 - 04:20 | 394009 jeff montanye
jeff montanye's picture

whatever.  but you are desperately wrong that the bailout of the tbtf in any way helps the broader economy.  it does not.  a receivership type fdic handling of huge bank insolvency is as effective as for smaller banks.  much more since the alternative, apparently, is this wretched zombie bank/master bank tbtf paradigm.  please investigate the comparison of economic performance of the nordic countries following their banking crisis and of japan's following its.  the evidence is unassailable.

Thu, 06/03/2010 - 22:54 | 393573 PhattyBuoy
PhattyBuoy's picture

... almost 40 million are in "bread lines" - I mean food stamps !!

Fri, 06/04/2010 - 07:01 | 394068 cowdiddly
cowdiddly's picture

26 million unemployed are waiting for a slice now.

Fri, 06/04/2010 - 18:31 | 396065 CB
CB's picture

bullshit.  the economy would be recovering instead of continuing to fail

Thu, 06/03/2010 - 22:40 | 393542 AccreditedEYE
AccreditedEYE's picture

Great piece on this subject courtesy of Whalen (not Smithers) for any who missed it. see: Ideas Have Consequences: The Importance of a Narrative
By Peter Wallison
http://us1.institutionalriskanalytics.com/pub/IRAMain.asp

Thu, 06/03/2010 - 23:09 | 393607 SilverIsKing
SilverIsKing's picture

Yet Geith-fuck-ner goes to the G20 to discuss a bank tax for bank bail outs.

Which is it?  End TBTF or more razzle dazzle to keep TBTF going?

 

Thu, 06/03/2010 - 23:20 | 393630 Problem Is
Problem Is's picture

"Geith-fuck-ner"

LOL.

Timmay G Resembles That Remark
Although I always consider Lil' Timmay the classic Cheese Dick...

Thu, 06/03/2010 - 22:16 | 393480 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

I am waiting for them to slush funds to smaller banks and then forcing the banks to make loans based on some "do or die" appoach by Obama, thus causing hyperinflation of the doelarr.  I am waiting......

Thu, 06/03/2010 - 22:27 | 393514 tip e. canoe
tip e. canoe's picture

your wish is my command, sir lennon, said big ben...

http://www.businessweek.com/news/2010-06-03/bernanke-says-u-s-unemployme...

"Federal Reserve Chairman Ben S. Bernanke said he’s concerned about the costs U.S. joblessness is imposing on the economy and that the central bank is telling field examiners to encourage lending to creditworthy businesses."

Fri, 06/04/2010 - 19:00 | 396108 Mr Lennon Hendrix
Mr Lennon Hendrix's picture

Muchos gracias!  I know they want to, will the do it?  Velocity would skyrocket.

Thu, 06/03/2010 - 22:17 | 393486 buzzsaw99
buzzsaw99's picture

Prove your outrage - resign.

Thu, 06/03/2010 - 22:22 | 393495 Crab Cake
Crab Cake's picture

+1

Resign, and take as many documents with you as you can.

The Fed must die! Abolish it, or burn it to the ground.

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, will rout you out." - President Andrew Jackson

Thu, 06/03/2010 - 22:49 | 393561 E pluribus unum
E pluribus unum's picture

He's not outraged enough to resign...Just to piss and moan because he knows that what he proposes will never see the light of day. He's "our populist" so remember that when they start hanging the bankers. Complete and utter sideshow.

Thu, 06/03/2010 - 22:40 | 393540 LeBalance
LeBalance's picture

I am a paid actor, given the scripted part of the character that rales and shakes his fist.  I distract the riled public from doing anything.  That is my function.

Thu, 06/03/2010 - 22:53 | 393567 tip e. canoe
tip e. canoe's picture

i'm not really a fed governor, i just play one on tv.

Thu, 06/03/2010 - 23:16 | 393622 Miles Kendig
Miles Kendig's picture

+ inf

Thu, 06/03/2010 - 22:26 | 393510 Xibalba
Xibalba's picture

Talk about being a day late and a dollar short.  All this rhetoric and no action is the real moral hazard. 

Thu, 06/03/2010 - 22:47 | 393556 Greater Fool
Greater Fool's picture

The main problem with this argument is summarized in a single counterexample: LTCM. An entity does not have to be big in order to pose a systemic risk capable of crashing the world financial system.

I gather the theory following that event was that allowing publicly traded, federally regulated companies to do the work that would otherwise be done by the LTCM's of the world would make problems easier to spot, prevent, and handle if they arose.

Obviously Fisher does not agree, but I still don't think that the events of 2008 necessarily demonstrate that this idea is incorrect.

Fri, 06/04/2010 - 04:31 | 394015 jeff montanye
jeff montanye's picture

ltcm wasn't bailed out by the taxpayer.  it was bailed out by wall street firms.  it was a hedge fund not a bank or brokerage house.  the hedge funds continued exactly as before; the "federally regulated" (hah!) companies didn't "do the work" any more than they did before.  other than that your argument is cogent.

Fri, 06/04/2010 - 14:13 | 395368 Greater Fool
Greater Fool's picture

You might want to find out what LTCM was actually doing before you reply. Many banks--not all US-based--were brought to the table by the Fed to organize a resolution. Not all signed on: BNP Paribas was holding so much collateral on some vol insurance LTCM had sold them that they preferred to take the collateral. Made a nice amount of money at it, too. Did it ever occur to you to wonder why greedy banks were willing to pay money to sort the mess out?

What hedge funds do is take risk off the books of other entities. In the "small bank / no trading" model being bandied about, there will be lots and lots of money to be made doing just this. The risk will vanish from bank balance sheets in its direct form, to be replaced by "counterparty risk." The counterparties will be unregulated, secretive entities; they will all but inevitably become much larger than the banks. It is easy to imagine a case in which Citadel becomes the largest "bank" in the US if a radical breakup of regulated institutions is initiated.

Thus, the foreseeable result of this legislation is not that no institution becomes TBTF, but instead that all TBTF financial institutions are "off the grid" and subject to essentially no regulation. Sound good to you? Not to me.

Fri, 06/04/2010 - 06:16 | 394052 AnAnonymous
AnAnonymous's picture

Too big to fail is too often related to an idea of size.

 

It might be that the too big to fail banks grow even more too big to fail banks after shrinking.

Thu, 06/03/2010 - 22:48 | 393558 fluorideintapwa...
fluorideintapwaterisbadforyou's picture

The Fed must die! Abolish it, or burn it to the ground.

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, will rout you out." - President Andrew Jackson

Thu, 06/03/2010 - 23:06 | 393600 Florida Joe
Florida Joe's picture

Go Andrew!

 

Where are any such statesmen, and true patriots, today?

Fri, 06/04/2010 - 08:16 | 394187 Brett in Manhattan
Brett in Manhattan's picture

That's some good stuff, right there.

Thu, 06/03/2010 - 23:02 | 393588 Hansel
Hansel's picture

Fisher: "blah blah blah"

Thu, 06/03/2010 - 23:14 | 393602 Miles Kendig
Miles Kendig's picture

Too bad I cannot but hold these comments as suspect.  After all, by serving the fed he is serving the continuation of the TBTF.  If his comments were actually serious and not some preparation to a future point out the "debate" narrative either he would resign, become a Miles Kendig or both.

Weak kneed POS MF'er whom I will still love and push to actually stand and take positive action on his principles, if he actually has any beyond the sociopathic standard of a fed official.

Thu, 06/03/2010 - 23:26 | 393649 Kali
Kali's picture

TD love the "vital going viral" comment.  Like opportunistic pathogens.  They are everywhere in/on the body, don't usually kill the host, till they find a weakness in the immune system.  Sorta like MRSA. And about as useful.  :)

Thu, 06/03/2010 - 23:35 | 393671 trav7777
trav7777's picture

Why do the economists seem like fish out of water?

Because they are.  They don't understand the nature of their own product, debt.

Debt-based money is its own systemic risk as a matter of basic mathematics.

Fri, 06/04/2010 - 02:32 | 393931 faustian bargain
faustian bargain's picture

Almost all of our current problems can be seen as rooted in fundamental misunderstandings of risk, especially the systemic risk inherent in attempting to control complexity (chaos?) in a centralized way. As Taleb might say, it's the misapplication of Gaussian models to Mandelbrotian reality.

Fri, 06/04/2010 - 00:31 | 393759 TooBearish
TooBearish's picture

TBTFs are here to stay as long as the money train is flowing into Barney Franks oft violated hind quarters...also ifn JPM and GS were broken up how the fuk is the FED gunna control prices as it will become very difficult to control rates and commodities while goosing spoos thru eight entities instead of 2.....

Fri, 06/04/2010 - 00:44 | 393773 Augustus
Augustus's picture

Once US banks were limited to taking deposits within their own states.   Then it was having a branch within the state.  Intrastate banking seemed to be a good move but it lead to all of the bank roll ups of the local banks that actually knew the borrowers.

Part of the argument in favour of the Very Big Bank was to make US banks able to fund larger loans for InterNational corporations.  Otherwise the business would go to the Euro banks to earn the "profits."  Of course bank profits are always the result of leverage of deposits and spreads

The questions is:
So what if the Euros banks fund larger loans?  And if the larger loans cannot be funded, the borrowerer will only have to come to the deal with their own equity.  Is more equity a bad resriction?  Or is realy a problem if banks only fund lending with greater margins and more profitability?

Fri, 06/04/2010 - 07:18 | 394086 John McCloy
John McCloy's picture

   Today is an excellent opportunity for someone to open a new bank focused entirely on being the anti-TBTF.  Simple marketing campaign of, "We are with you.Support true American business"

    Make a solemn promise to never engage in the complexities of the markets. Offer basic financial services such as trading for customers, no financial advice and simply a lender. Good ole fashion US of A banking. Propose yourselves as the anti-bailout bank and within 5 years TBTF would lose much of their deposit base.

Fri, 06/04/2010 - 01:45 | 393861 Bearish News
Bearish News's picture

Fisher talks pretty sometimes. But don't forget he's the dude who emailed Geithner during the heat of the bailout-mania, and said, "Illigitimum non carborundum".

That's a stuck-up Harvard-club assed (Latin) way of saying "Don't Let the Bastards Get You Down".

So Bastards = Those stupid and angry American citizens. Fisher implies that Geithner are the good guys are being unfairly maligned.

Fisher has gotten better over the years, and he and Hoenig do deserve some respect. But based on their history, not a big fan.

Fri, 06/04/2010 - 02:28 | 393924 faustian bargain
faustian bargain's picture

'Illigitimum non carborundum' isn't stuck-up, it's just annoying and dorky. Something someone would say who doesn't get out very much aside from the monthly D&D miniature wargame club meeting.

Fri, 06/04/2010 - 08:13 | 394178 Brett in Manhattan
Brett in Manhattan's picture

It smacks of someone trying a bit too hard to sound erudite.

Fri, 06/04/2010 - 02:32 | 393928 Apostate
Apostate's picture

Um... shrinking the TBTFs will do nothing. The problem is the Fed and the post-Bretton Woods currency system.

And the method for collecting taxes, which has been obsolete for decades.

The only thing even keeping payrolls together is legal overhead and - I'm not even joking - CEO patriotism.

You have to be deluded or an America-worshipper to keep significant staff in the US.

Fri, 06/04/2010 - 03:09 | 393961 lolmaster
lolmaster's picture

oh please this guy is a side show act

funny how he doesnt consider shrinking the mother of all megabanks the FRB

Fri, 06/04/2010 - 03:26 | 393969 killben
killben's picture

If all this noise among the Fed governors leads to a mutiny at the Fed then that would be great.

 

If at all there is one guy who deserves to be lynched it is Ben Bernanke.. Sooner the better.

Fri, 06/04/2010 - 06:19 | 394053 AnAnonymous
AnAnonymous's picture

Participants seeing the too big to fail banks as vital to their national policies/economies are probably the only ones willing to retain a bit of sincerity.

Like telling the US military occupation of the world is vital to the US national US policy.

Fri, 06/04/2010 - 07:10 | 394076 Mako
Mako's picture
"Says Only Way To Remove Systemic Risk Is Shrinking The Megabanks"

The only way to remove systemic risk is to remove the system, I have no idea what these dipshits are talking about. 

It's over.

Fri, 02/25/2011 - 08:24 | 996473 george22
george22's picture

Resign, and take as many documents with you as you can.

The Fed must die! Abolish it, or burn it to the ground.

"Gentlemen, I have had men watching you for a long time and I am convinced that you have used the funds of the bank to speculate in the breadstuffs of the country. When you won, you divided the profits amongst you, and when you lost, you charged it to the bank. You tell me that if I take the deposits from the bank and annul its charter, I shall ruin ten thousand families. That may be true, gentlemen, but that is your sin! Should I let you go on, you will ruin fifty thousand families, and that would be my sin! You are a den of vipers and thieves. I intend to rout you out, and by the grace of the Eternal God, will rout you out." - President Andrew Jackson

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