Bad news for fixed income market monopolist Goldman Sachs. Kansas City Fed President Thomas Hoenig, in response to a question from University of Maryland Professor Carmen Reinhardt said "dismembering firms is a fair thing to consider." Hoenig further clarified that regulators "have people who are experts who understand what's going on inside institutions who could figure out how to carve out" some parts of a financial institution if they are taking undue risks with taxpayer backing." Surely, we expect Lloyd Blankfein to comment promptly on how even the Federal Reserve is now thoroughly underappreciating the divine nature of its prop/flow-focused business model, and how originating the proactively entire volume of OTC quote flow is just a natural side effect of completely cornering the CDS, bond and loan market.
More details from Market News:
Hoenig said there is a strong tendency in financial crises to bail out firms, but he said that in some instances "you have to allow institutions to fail and then have renewal."
He emphasized the need to have an FDIC-style resolution authority to deal with insolvent institutions which could seize a systemically important financial firm before it fails, change management, impose losses on shareholders and "put creditors in an adverse position."
Under Hoenig's scheme shareholders would be "wiped out," while "longer term secure creditors are protected but don't have immediate access to their funds."
He said regulators should "designate banks in advance that are systemically important" and make clear what steps will be taken if they become insolvent. In the meantime, he said regulators should apply certain rules, such as "substantially higher" capital requirements and loan-to-value ratios. He suggested banks with $50 billion or more of assets should be so designated.
"You really do need to have process for dealing with failing institutions," said Hoenig.
"Preparation is really important," he said. "We have to define 'systemic' to get things started to deal with this issue" of too big to fail.
The larger "systemic" banks and their creditors should be "put them on notice ...not that they're going to be bailed out, but that they're not going to be bailed out ... so creditors are not as protected."
Hoenig said that if creditors know they bear more risk in the event of failure, he said that should "begin to mitigate moral hazard."
All of this is certain to incite another PR fiasco by Goldman, which (rightfully) will realize that the Fed President's words are aimed squarely at its operations.