The Moment When The Fed Admits It Has Become The Market's Muppet
The following exchange between then-Kansas Fed president (and current FDIC director) Thomas Hoenig and the Chairsatan, uttered during the historic Sept 16, 2008 FOMC meeting, is of particular importance for four reasons: 1) it appears to be the first instance in the Fed records, where the phrase "too big to fail" is memorialized; 2) it highlights something that has become all too clear by now: in giving to a culture of moral hazard, the Fed is now being openly "played" by the market (read the big banks); 3) it confirms that the Fed has learned zero lessons from the crisis and 4) the thinking behind the "Bernanke (global) Put" is laid out for all to see.
MR. HOENIG. Mr. Chairman, I have thought about this considerably because I think we have come to a time in our history when we have institutions that clearly ought to be and may in fact be too big to fail. I think we tend to react ad hoc during the crisis, and we have no choice at this point. But as you look at the situation, we ought, instead of having a decade of denying too big to fail, to acknowledge it and have a receivership and intervention program that extends some of the concepts of the FDIC but goes beyond that. That is, if you are insolvent, it is not a central bank issue—we are a liquidity provider—and therefore the government comes in. But unlike the GSEs, everyone has to take some hit—the equity holders, certainly the preferred stockholders, also the subordinated-debt holders, and perhaps the senior ones—by assuming a certain amount of loss. They would have immediate access to—pick a number—80 percent. The research would help us pick that number, and they can have access, but the rest becomes a subordinate-subordinate position after the liquidation so that you have still a sense of market discipline in play and you don’t get the system gaming it in that, if you know there’s a bailout coming, you buy the debt and sell the equity short to make a bundle. I think therein lie the distortions that are absolutely detrimental to the long-run health of the economy.
Regarding how we go forward, I think we are going to have many lessons from this. Part of the problem has been very lax lending and, obviously now, weaknesses in some of the oversight. Also a history of our reacting from a monetary policy point of view to ease quickly to try to take care of the problem and, therefore, to create a sense in the market of our support has raised some real moral hazard issues that we now need to begin to remedy as we look forward in dealing with future receiverships. We are in a world of too big to fail, and as things have become more concentrated in this episode, it will become even more so.
CHAIRMAN BERNANKE. I certainly agree—and the Treasury Secretary and I have said publicly—that we need a strong, well-defined, ex ante, clear regime. But we have the problem now that we don’t have such a regime, and we’re dealing on a daily basis with these very severe consequences. So it is a difficult problem.
MR. HOENIG. I think what we did with Lehman was the right thing because we did have a market beginning to play the Treasury and us, and that has some pretty negative consequences as well, which we are now coming to grips with.
Yes Tom, unfortunately 5 years later, not one lesson has been learned, as for the "market playing" you and the Treasury, we too can't wait for the moment when not even the market can "game" the clueless mandarins at the Marriner Eccles building, and it all comes crashing down...
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