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A Man With a Plan

By: Bill Poquette

Just over a year ago, Richard W. Fisher, president of the Federal Reserve Bank of Dallas, made a speech at Columbia University in which he called for an international accord to break up huge financial institutions considered too big to fail. “There is only one fail-safe way to deal with too big to fail,” he said. “I believe that too-big-to-fail banks are too dangerous to permit.”

Fisher revisited the issue again last month, outlining a bold plan in remarks before the Committee of the Republic in Washington, D.C. Previously thought of as islands of safety in a sea of risk, these banks became the enablers of the financial tsunami of 2007–2009, he declared.

TBTF megabanks receive far too little regulatory and market discipline, in Fisher’s view. “This is unfortunate because their failure, if it were allowed, could disrupt financial markets and the economy,” he said, adding that for all intents and purposes they have not been allowed to fail. “Knowing this, the management of TBTF banks can, to a large extent, choose to resist the advice and guidance of their bank supervisors’ efforts to impose regulatory discipline.”

The Dodd-Frank Act addresses the resolution of TBTF institutions under the Orderly Liquidation Authority, Fisher acknowledged. “This is quasi-nationalization, just in a new and untested format,” he said. Another alternative would be to have another systemically important financial institution acquire the failing institution. But we have been down that road and all that does is expand the risk and compound the problem, in Fisher’s opinion.

The approach of the Dallas Fed neither expands the reach of government nor further handicaps the 99.8 percent of community and regional banks, Fisher advised his Washington audience. “It calls for reshaping TBTF banking institutions into smaller, less-complex institutions that are economically viable; profitable; competitively able to attract financial capital and talent; and of a size, complexity and scope that allows both regulatory and market discipline to restrain excessive risk-taking,” he said.

“It calls first for rolling back the federal safety net to apply only to basic, traditional commercial banking,” he explained. “Second, it calls for clarifying, through simple, understandable disclosures, that the federal safety net applies only to the commercial bank and its customers and never ever to the customers of any other affiliated subsidiary or the holding company.

“We recognize that undoing customer inertia and management habits at TBTF banking institutions may take many years,” Fisher continued. “During such a period, TBTF banks could possibly sow the seeds for another financial crisis. For these reasons, additional action may be necessary. The TBTF BHCs may need to be downsized and restructured so that the safety-net-supported commercial banking part of the holding company can be effectively disciplined by regulators and market forces.”

In Fisher’s view, there should be more than the present two solutions to TBTF, which he described as “bailout or the end-of-the-economic-world-as-we-have-known-it.” Both choices are unacceptable to the Dallas Fed president. “The next financial crisis could cost more than two years of economic output, borne by millions of U.S. taxpayers,” he warned. “To us, the remedy is obvious: end TBTF now; end TBTF by reintroducing market forces instead of complex rules, and in so doing, level the playing field for all banking institutions.”

Fisher makes a compelling argument that merits further study and discussion by regulators and lawmakers. Hopefully, it will spur continuation of a constructive dialogue on this issue.

Bill Poquette is editor-in-chief of BankNews.

Copyright (c) February 2013 by BankNews Media