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The Dallas Fed Releases Report on Ending TBTF


Jan 18 - A bold plan to break up financial institutions deemed too big to fail was revealed by Richard W. Fisher, president of the Federal Reserve Bank of Dallas, in remarks last week before the Committee of the Republic in Washington, D.C. These banks, previously thought of as islands of safety in a sea of risk, became the enablers of the financial tsunami of 2007-2009, he declared.

“The 12 institutions that presently account for 69 percent of industry assets are candidates to be considered TBTF because of the threat they could pose to the financial system and the economy should one or more of them get into trouble,” Fisher explained. “By contrast, should any of the other 99.8 percent of banking institutions get into trouble, the matter most likely would be settled with private-sector ownership changes and minimal government intervention.”

The 12 TBTF megabanks over $250 billion in asset size 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. “For all intents and purposes, we believe that TBTF banks have not been allowed to fail outright. 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 concern of resolving TBTF institutions under the Orderly Liquidation Authority, Fisher acknowledged. “This is quasi-nationalization, just in a new and untested format,” he said.

“In Dallas, we consider government ownership of our financial institutions, even on a ‘temporary’ basis, to be a clear distortion of our capitalist prionciples.”

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. “In addition, perpetuating the practice of arranging shotgun marriages between giants at taxpayer expense worsens the funding disadvantage faced by the 99.8 percent remaining — small and regional banks,” he said.

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; profi table; 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.

The proposal can be accomplished with minimal statutory modification and implemented with as little government intervention as possible, he believes. “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. The shadow banking activities of financial institutions must not receive taxpayer support.

“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. And there will likely have to be additional restrictions (or possibly prohibitions) on the ability to move assets or liabilities from a shadow banking affiliate to a banking affiliate within the holding company.”

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.

“That horrendous cost must be weighed against the supposed benefits of maintaining the TBTF status quo. 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.”

Click here for the report.