Fed's Kashkari Releases Plan To End "Too Big To Fail", Compares Banks To Terrorists

Tyler Durden's picture

In the latest reminder that 7 years after the financial crisis, the US banking system still remains a systemic risk, Minneapolis Fed President Neel Kashkari today released four-step plan to end too-big-to-fail problem. In his speech to the economic club of New York, the former Goldman banker said that while significant progress has been made to strengthen U.S. financial system, biggest banks continue to pose a significant, ongoing risk to our economy.

Under the “Minneapolis Plan,” there would be “fewer mega banks,” community banks would thrive, and mid-sized banks would make up larger share of system.

A summary of the proposed Fed plan argues that large banks already under shareholder pressure to reorganize will face increased pressure to consider breaking themselves up.

  • The plan, which will naturally be ignored by the banks themselves and the authorities, is culmination of efforts since February that brought together experts on financial crises and bank regulation, such as former Fed Chairman Ben Bernanke and ex-central bankers Roger Ferguson and Randall Kroszner according to Bloomberg.
  • Largest banks “refused to participate” for fear their presence would be viewed as acknowledgment that TBTF problem exists.

The first two steps would be to increase capital requirements for banks with assets of more than $250b to 23.5% of risk- weighted assets, and to have Treasury secretary either certify that large banks are no longer systemically important or subject those institutions to increases in capital requirements of as much as 38% over time. Additionally, the minneapolis Fed plan would only count common equity as capital.

The threat of massive increases in capital will provide strong incentives for largest banks to restructure so that they are no longer systemically important. The proposed approach is similar to those regulators have taken with nuclear power plants, imposing such tight restrictions so as to minimize risk of failure.

The other two steps would be to impose tax on borrowings of shadow banks with assets over $50b, and reducing regulatory burden on community banks.

Kashkari defended his plan by saying that most companies outside financial services industry have much bigger buffers than banks. Under his plan, which requires bigger buffers, “some banks would probably have business models that don’t work. They probably already have business models that don’t work,” he says, adding: “That’s not our problem.”

It is however, the banks' problem, and is another reason why the plan will be soundly ignored. "My hope is that there’s interest on both sides of the aisle for this type of work and analysis." Wrong.

Undeterred, Kashkari went on to say that his plan “would require legislation” and in case there was confusion, he said that “what we are proposing is a major restructuring of our financial sector."

Too bad such a "restructuring" will not take place until after the next crisis.

The plan's four proposed steps are the following:

Step 1. Dramatically increase common equity capital, substantially reducing the chance of bailouts

 

We will require covered banks to issue common equity equal to 23.5 percent of risk-weighted assets, with a corresponding leverage ratio of 15 percent. This level of capital nearly maximizes the net benefits to society from higher capital levels. This first step substantially reduces the chance of public bailouts relative to current regulations from 67 percent to 39 percent. This substantial improvement in safety comes at a relatively low cost of gross domestic product (GDP). Covered banks will have five years to come into compliance with this requirement

 

Step 2. Call on the U.S. Treasury Secretary to certify that covered banks are no longer systemically important, or else subject those banks to extraordinary increases in capital requirements, leading many to fundamentally restructure themselves

 

Once the new 23.5 percent capital standard has been implemented, we will call on the Treasury Secretary to certify that each covered bank is no longer systemically important. Our proposal gives the Treasury Secretary the discretion to make this determination so that it can rely on the best information and analysis available. We suggest that the Treasury start by reviewing existing metrics of systemic risk used to determine current GSIB surcharges. The Treasury will also have the authority to look beyond covered banks in making its determination. If the Treasury refuses to certify that a covered bank is no longer systemically important, that bank will automatically face increasing common equity capital requirements, an additional 5 percent of risk-weighted assets per year. This process will begin five years after enactment of the Minneapolis Plan. The bank’s capital requirements will continue increasing either until the Treasury certifies it as no longer systemically important or until the bank’s capital reaches 38 percent, the level of capital that reduces the 100-year chance of a crisis below 10 percent.

 

Step 2 is a critical step for ending TBTF. Under the current regulatory structure, there is no explicit timeline for ending TBTF, and regulators never have to formally certify that large banks and shadow banks are no longer systemically important. Instead, banks and designated nonbank financial firms can continue to operate under their explicit or implicit status as TBTF institutions potentially indefinitely. The Minneapolis Plan reverses this approach and gives the Treasury Secretary a new mandate with a hard deadline. Five years after enactment of the Minneapolis Plan, the Treasury either will certify that large banks are no longer systemically important or those banks will face extraordinary increases in equity capital requirements.

 

We believe that these automatic increases in capital requirements will lead banks to restructure themselves such that their failure will not pose the spillovers that they do today and lead to future bailouts. We chose the capital level that reduces the probability of a bailout in Organisation for Economic Co-operation and Development (OECD) countries to 10 percent or below while keeping total costs below benefits. This level of capital is appropriate for the largest banks that remain systemically important, as their failure alone could bring down the banking system.

 

The only banks that could remain systemically important after the Minneapolis Plan has been fully implemented would have 38 percent common equity capital, with a risk of failure that is exceptionally low. This is a similar approach regulators have taken with nuclear power plants: While not risk free, they are so highly regulated that the risks of failure are effectively minimized. Step 2 of the Minneapolis Plan reduces the chance of future bailouts to 9 percent over 100 years.

 

Step 3. Prevent future TBTF problems in the shadow financial sector through a shadow banking tax on leverage

 

We discourage the movement of activity from the banking to shadow banking sector by levying a shadow bank tax. The tax equalizes the funding costs between the two sectors. The tax will have two rates. To equalize funding costs with a 23.5 minimum equity requirement, we would levy a tax on shadow bank borrowing of 1.2 percent. This tax rate would apply to shadow banks that do not pose systemic risk as judged by the Treasury Secretary. A tax rate equal to 2.2 percent would apply to the shadow banks that the Treasury refuses to certify as not systemically important. Thus, the shadow bank tax regime mirrors our two-tier capital regime. These taxes should reduce the incentive to move banking activity from highly capitalized large banks to less-regulated firms that are not subject to such stringent capital requirements. Nonbank financial firms that fund their activities with equity do not pay the tax. Shadow banks will have five years from enactment of the Minneapolis Plan before they begin paying the shadow bank tax. The Treasury Secretary will start making certifications as to the systemic importance of shadow banks at that point. Here, too, we grant the Treasury discretion to look across all nonbank financial firms in its certification process.

 

Step 4. Reduce unnecessary regulatory burden on community banks

 

Ending TBTF means creating a regulatory system that maximizes the benefits from supervision and regulation while minimizing the costs. The final step of the Minneapolis Plan would allow the government to reform its current supervision and regulation of community banks to a system that is simpler and less burdensome while maintaining its ability to identify and address bank risk-taking that threatens solvency.

* * *

One interesting section lays out the MN Fed's calculation of a probability of bailout in the next 100 years:

Alongside this, Kashkari lays out not only the change of a bailout in the next 100 years, but the overall cost of this as a percentage of GDP.

We have developed a framework for assessing safety and costs. The first column says “Chance of a Bailout in the Next 100 Years.” The IMF has compiled a database of financial crises around the world that we use to assess how frequently financial crises have happened in the past and what regulations were in place when those crises happened. Fortunately, financial crises are infrequent events, but that makes them hard to predict, like terrorist events or earthquakes. This IMF database contains the best data available to look at the history of financial crises and make informed estimates about their future likelihood. We look at a 100-year time horizon because the Great Depression took place in the 1930s and the recent financial crisis in 2008, approximately 80 years later. Aiming to prevent financial crises over a 100-year time horizon seems like a reasonable goal, given how devastating crises are when they hit.

 

On the right side of the table, we list costs. Here we calculate the present value of future costs, using a similar method as do regulators around the world.

 

We set as a baseline the capital regulations that existed in 2007, before the onset of the recent financial crisis. An examination of the IMF database of crises and the regulations that existed in 2007 implies an 84 percent chance of a crisis in the following 100 years. Obviously, the crisis in fact happened the next year. The database offers a view of how likely crises are to happen, not when exactly they will happen. In terms of costs, we set the 2007 regulations as a baseline, so we assume those costs are zero for comparison purposes.

 

Next we look at the current capital regulations, which have increased capital requirements relative to 2007. As you can see from the table, the probability of a future financial crisis has been reduced, from 84 percent to 67 percent over the next 100 years. That is a modest improvement in safety at a cost of 11 percent of GDP. Is 11 percent of GDP a lot or a little?

 

Here we see that the Bank for International Settlements’ consensus estimate for the typical cost of a banking crisis is 158 percent of GDP, which for the U.S. economy equals roughly $28 trillion. This is the present value of the long-term effects of a banking crisis. As we have seen since the recent crisis, the U.S. economy has been growing much more slowly than had been previously expected. These long-term effects are fairly typical for financial crises, which as you can see, are extraordinarily costly for society. Against that enormous cost, 11 percent of GDP seems to me to be a small price to pay for a modest increase in safety.

* * *

Ultimately, the goal of Minneapolis Plan is to "educate public and elected representatives about options." Amusingly, in doing so Kashkari ends up comparing American banks to terrorists:

One useful analogy that helps highlight the trade-off of costs and benefits is the risk of terrorism. Intuitively, the public understands that we as a society cannot eliminate all risk of a future terrorist attack. It is simply impossible to make that risk zero. And the public intuitively understands that increased physical safety isn’t free. There are costs associated with hiring additional law enforcement officers, for example, or installing more metal detectors. Since we cannot eliminate all risk, we have to decide how much safety we want and what price we are willing to pay for that safety. The same is true for financial crises. We cannot make the risk zero, and safety isn’t free. Regulations can make the financial system safer, but they come with costs of potentially slower economic growth. Ultimately, the public has to decide how much safety they want in order to protect society from future financial crises and what price they are willing to pay for that safety.

An apt analogy, if perhaps not one the banks will be particularly delighted with.

Kashkari's full speech can be found here, while readers can access the full 53 page plan at the following URL.

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Looney's picture

Am I going “Full Gartman” or has the Zero Hedge logo been shrinking lately, little by little?

I ain’t bitching, just wanted to make sure… before I surrender to the Mental Health authorities.   ;-)

Looney  

1980XLS's picture

Bankster on Bankster Crime.

He better watch his back

Ghost of PartysOver's picture

Me thinks he is positioning to be the next Fed Chairman.  This is his "Trial Balloon" if you will.

Dr. Richard Head's picture

It's tinkering on the edges of the debt-based fiat money system.  

CJgipper's picture

You may think just blowing it up all at once sounds like a terrific idea, but the reality would be quite different.  This phase out is a much better plan.

SomethingSomethingDarkSide's picture

Can we still beat their CEO's bloody and drag them through the streets?

Sages wife's picture

This guy oughta' know about financial terrorism; just ask Dennis Kucinich.

https://www.youtube.com/watch?v=BGdS63iSN1c

BennyBoy's picture

 

"...Compares Banks To Terrorists"

Kashkari is equivilant to Bin Laden or Ayman al-Zawahiri

JRobby's picture

Kashkari has it backwards (or at least on the wrong side of the sentence)

Terrorists should be compared to TBTF banks

Organized crime should be compared to TBTF banks

Antifaschistische's picture

Here's how to eliminate TBTF Banks.

1. Eliminate all Discount Window lending (eliminate all primary credit, secondary credit and seasonal credit programs from the FED)

2. End all Open Market Operations

3. End the Feds liquifiable account creation process with it's member banks

....so basically, eliminate the FEDs role in debt creation and virtual counterfeiting operations.   When you have the ability to legally counterfeit money, you end up growing and growing and growing as you gobble up the worlds assets.....thus....TBTF.

auricle's picture

Kashkari and his 100 year plan to stabilize banks. And this guy is in charge of a CB. 

 

 

Luc X. Ifer's picture

Patriot Act to be applied to the Banks on grounds of financial and social terrorism.

The Wizard's picture

That is sort of my opinion. They have created so many draconian laws to steal assets from people for next to nothing. Those same laws need to be applied to the banksters. They are the terrorists.

What has Cash n' Carry been drinking or smoking to, all of a sudden, come out with this proposition?

Luc X. Ifer's picture

Basically the banks assasinated their social enclave middle-class instead of supporting the enclave's wellbeeing they practically weakened it to the point of dissapearance for the benefit of just very few members of the same enclave, for something like this in ancient times when enclaves where self-governing you'll lost your head.

JRobby's picture

You could say that the mass foreclosure wave (which is starting back up now) was anticipated as a bonanza of the near future when sub-prime was exploding. But they are zip locked on that.

Many bank owned went to hedge funds, private equity and others that quickly found capital to take advantage of it.

Made a killing on the MBS's, then some more on repo flips.

jakesdad's picture

"roadmapping" is among the most undervalued skills in almost any industry/field!  it's easy to make a static assesment of what's wrong w/the status quo & it's even easiER to draw utopia on a whiteboard.  what's HARD is figuring out how to get from A to B w/o destroying the world in the process...

JRobby's picture

The "Phase Out" can be the only plan. It must be orderly.

Resolution Trust at least has some order to it. But the scale was much, much less.

BUT Glass-Steagall must be reinstated first. It worked. When it was repealed, it blew up in under 10 years. Of course it was helped by a lack of derivative regulation but regulation of derivatives was killed in '97 when GS was repealed.

11b40's picture

Slight correction - Glass-Steagall was repealed in 1999.

The other one that needs to be scrapped and started over is the Commodity Futures Modernization Act of 2000.  It is what lead to the huge explosion in derivatives.

These 2 Congressional actions in 1999 and 2000 gave the keys to the castle to the banksters and unleashed them on the entire world.  Bill Clinton signed both, but he had plenty of help from both sides of the aisle.  The banksters spread their bribe money around in a very non-partisan manner.

The_Dude's picture

Hmmm...do I trust this bankster and his plan that feigns to help the little guy? 

Not one fucking bit!!

realWhiteNight123129's picture

Nothing wrong with that!! If he brings the good old principles of McChesney Martin (he jailed the head of the NYSE after 1929).

With ideas like that he would be a great Fed Chairman, and he would shut the mouth of all the guys trying to tell that the new administration is just motivated by hatred against minorities and brown people.

What matters is if you have a good heart, and as an Hindu from Cashmire, he probably can not stand the extremist muslims, which is another good point to his credit.

 

Ghost of PartysOver's picture

I don't know much about the guy.  But this I do know, he is not Yellen, Bernake or Greenspan. 

Sick Underbelly's picture

Dude actually looks like a dude...scary skinhead...but, there's not much question about his "dudeness".  

 

Note: sarcasm on the "scary skinhead" part...so you don't get twisted and irritated.

francis_the_wonder_hamster's picture

You really owe it to yourself to learn about who Kashkari is.  He's a real piece of work. He actualy seemed sane when running for office as a Republican in Cali, but that's an easy comparison when compared to his opposition.  He's a disgraced technocrat.

The second I saw his name in this headline I knew his plan would be a non-starter for actually fixing problems.  

He says you can't eliminate bailout risk.  Yes, Neil, yes you can.

But the terrorist analogy is absulutely spon on.

Orly's picture

It is a well thought-out plan and it sounds like it would work.

I hope President Trump-or Paul Ryan- is paying attention.

:D

mkkby's picture

Well, it's really a small part of a good plan.

More capitalization obviously equals less risk.  But they have to tackle the hidden risk.  That means the derivatives, the offshore accounts and the incest-like ties to each other.  Roaches don't just hide in one place.

BTW, welcome back.  How is the FX trading going?

Jeffersonian Liberal's picture

What he's doing is proposing a restructuring of the financial/monetary system put in place in 1913.

Ain't gonna happen.

That structure was put in place specifically to ensure that a few, international mega-banks had complete control over the currencies, finances and economies of the industrial nations.

This is either controlled opposition coming down from the NY Fed (one ring to rule them all) to deceive Trump into thinking the Fed "can" be his friend, or this guy is, as you said, looking for a position on Trump's team.

 

HowdyDoody's picture

"Ultimately, the goal of Minneapolis Plan is to "educate public and elected representatives about options." Amusingly, in doing so Kashkjari ends up comparing American banks to terrorists:"

I thought a comparison to a mafia protection racket was more apprpriate. It went something like "bail us out or we take down your economy".

 

adanata's picture

 

O/T ... but speaking of 'terrorists'... Russians inquire why Clinton Foundation bought $137 million worth of illegal weapons and shipped them to the U.S.

You get three guesses. I have been certain both nuclear war and a significant EMP attack were 'off the table' because of the grave danger they would pose to the globalists themselves. Ah, but the most egregious effects of civil war is something they can remain above by living in highly secure and well protected areas. In addition, should conditions become more threatening to them personally, they can leave the country any time they like.  White people against everyone else? ....and everyone else being very well armed?

Mr T's picture

Hey fuckwit are you trying to ruin this site? A quick search finds this is a soorcha faal about as accurate as rite katz. If you are not an idiot please post a confirming link to your sensational revelation or just fuck off

adanata's picture

 

I apologize. You were right and I was wrong. I did not perform due diligence on this issue. I know better and it won't happen again. I have been jumping at shadows for the last couple of weeks... I'll restart my xanax program...and again, I apologize.

bh2's picture

Actually, I think he'd be a decent choice as the next FED head.

He's never been reluctant to point out the criminal behavior of banks and recommend specifically how to eliminate temptations they should not have. That actually makes him unusual among the crowd of elitist academics who know nothing.

Lynx Dogood's picture

As there influence grows their logo shrinks?

847328_3527's picture

Logo?

 

What logo? The tiny thing up in the right hand corner?

Bob's picture

Now that I've gotten used to using it and seeing the larger logo in the center of the page, I much prefer it there. 

Looks better, easier to reach and click centered in the larger size, imo.

BennyBoy's picture

 

ZeroHedge.com/ABC Media, LTD want you to go a little crazeee.....

Use uBlock to get rid of all the nutty ads.

DavidC's picture

Hi Looney,
It's been moved to the top tight and the text has been made smaller, from having been in the centre and larger.

Meanwhile the HOME/CONTRIBUTORS/NEWSLETTER/MORE headers look to me to be larger now.

It's all part of 'embracing change' and 'continual improvement' when nothing's broken and everything works. Standard for the modern world...

DavidC

toady's picture

Huh... the logo doubled in size, or more,  for me, about a week ago. I read ZH on an old S3... maybe the logo varies in size for differing platforms.

JimJinNJ's picture

I haven't read all this at all but I like Kashkari .  finally someone willing to put themselves against the big criminal enterprises.  next thing you know Pocahantas will be singing his praises.  

Bill of Rights's picture

Now they tell us, after they did all these Alphabet soup Q&E's, remember folks all this was done under the Obama administrations watch...ALL OF IT!

centerline's picture

Step 1.  Make arrests.

Step 2.  Convict.

Step 3.  Prison.

Banks have near perfect trading records for one reason only... the game is rigged.  Rigged game = RICO violations.

_ArC_'s picture

Step 3. Firing squad (sounds better)

Wahooo's picture

Listen up Trump!

Due North's picture

You just never know anymore if someone is genuine or just blowing sunshine up your ass.

markar's picture

this sounds like heresy coming from a Fed prez. Talk about biting the hand that feeds!

BandGap's picture

Sounds like predicting the car that just flew off the cliff will hit the ground (eventually). I am jaded to the point that this looks like a trial balloon to test the waters for massive banks failures.

 

SloMoe's picture
"Fed's Kashkari Compares Banks To Terrorists"

Man, if that isn't the pot calling the kettle bald...

chunga's picture

If I remember right Kashkari was a big ram-rod for TARP.

SloMoe's picture

Kashkari was Hank Paulson's right-tentacle helper...

Orly's picture

Which means- like the former Goldman/Soros-employed soon-to-be Treasury Secretary- he knows how to fix it.

 

:D