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A New Chapter Opens

By: Bill Poquette

The issue of what to do about too-big-to-fail banks made headlines last month when Richard Fisher, president of the Federal Reserve Bank of Dallas, spoke out in favor of an international accord that would break up these huge financial institutions “to more manageable size.” Also in December, a hearing was conducted by Sen. Sherrod Brown, D-Ohio, chairman of the Senate Banking Subcommittee on Financial Institutions and Consumer Protection, to examine “how new oversight authority over large financial institutions should prevent Wall Street mega-banks from hurting Main Street consumers, small businesses and American taxpayers.”

“As students, you should know that financial booms and busts are a recurring theme throughout history and that bankers and their regulators suffer from recurring amnesia,” Fisher said in an address to Columbia University’s Politics and Business Club. “They periodically forget the past and all the lessons of history, tuck into some new financial, quick-profit fantasy like the slicing and dicing and packaging of mortgage financing, and underestimate the risk of growing into unmanageable and unsustainable size, scale and complexity as they overindulge in that new financial fantasy. Invariably, these behemoth institutions use their size, scale and complexity to cow politicians and regulators into believing the world will be placed in peril should they attempt to discipline them.”

Noting that specific Dodd-Frank regulations have yet to be finalized, Fisher invoked his former colleague, Tom Hoenig, retired president of the Federal Reserve Bank of Kansas City and nominee for vice chairman of the FDIC, calling him one of the harshest critics of the treatment of systemically important financial institutions. Fisher recalled Hoenig’s argument that the very existence of SIFIs is “fundamentally inconsistent with capitalism” and “inherently destabilizing to global markets and detrimental to world growth.”

Fisher sees an Achilles’ heel in Dodd-Frank. “It states that in the disposition of assets, the FDIC shall ‘to the greatest extent practicable, conduct its operations in a manner that ... mitigates the potential for serious adverse effects to the financial system.’ This is entirely desirable,” Fisher said. “Nobody wants to initiate serious financial disruption. But directing the FDIC to mitigate the potential for serious adverse effects leaves plenty of wiggle room for fears of ‘cascading defaults’ and ‘catastrophic risk’ to perpetuate ‘exceptional and unique’ treatments, should push again come to shove.”

Senator Brown is another skeptic. At his December hearing he raised these questions:

Will regulators use these authorities to downsize these institutions in order to prevent the next financial crisis — particularly when they had some similar powers prior to the last crisis?

Will the markets force these institutions to increase their equity funding or exit risky lines of business?

Is it even possible to understand or unwind trillion-dollar institutions that have hundreds of diverse lines of business and operate in over 100 countries?

Should we continue to put all of our faith in regulators, or is it time to address too big to fail by putting reforms into law?

In Fisher’s view, “There is only one fail-safe way to deal with too big to fail. I believe that too-big-to-fail banks are too-dangerous-to-permit.”

It appears Tom Hoenig no longer needs to feel like a voice in the wilderness on the failure to effectively address too big to fail.

Bill Poquette is editor-in-chief of BankNews.

Copyright (c) January 2012 by BankNews Media