Category Archives: Too big to fail

Legislation seeks return of the Glass-Steagall Act

Posted on by
Reply

What do U.S. Representatives Collin Peterson (D-Minn.), Tim Walz (D-Minn.), and Keith Ellison (D-Minn.) have in common with Dan Lipinski (D-Ill.), Janice Schakowsky (D-Ill.), Peter Visclosky (D-Ind.), and John Dingell (D-Mich.)? They are co-sponsors of HR 129, a bill to restore the Glass-Steagall Act. The bill has 53 co-sponsors.

A number of legislative approaches are being considered for dealing with the too-big-to-fail problem, including this effort to restore the 1933 law which went away with the passage of the Gramm-Leach-Bliley Act of 1999. The LaRouche Political Action Committee is the chief proponent of HR 129, or the “Return to Prudent Banking Act of 2013.”

There are a number of people calling for the reinstitution of Glass-Steagall, or the separation of investment and commercial banking. The South Dakota state legislature passed a resolution on Feb. 28 calling on the U.S. Congress to reinstate Glass-Steagall.

In Minnesota, a resolution (HF 1744) has been introduced which would call on Congress to separate commercial and investment banking functions. The Commerce and Consumer Protection Finance and Policy Committee of the Minnesota House of Representative is considering the resolution, which is sponsored by four Republicans and two Democrats.

Resolutions supporting the reinstatement of Glass-Steagall have popped up on other state legislatures this session, including Montana.

The LaRouche PAC web site states: “Glass-Steagall is the indispensable first step to global economic recovery. It will immediately halt the onset of hyperinflation, remove government commitment from toxic debts, end too-big-to-fail, and force separation of commercial banking functions from investment banking functions.”

In the last Congressional session, legislation to restore Glass-Steagall gained support from 84 co-sponsors.

Hoenig’s timing is inpeccable

Posted on by
Reply

There’s a story in Saturday’s Wall Street Journal about the timing of J.P. Morgan’s $2 billion trading loss and how it helps advocates of the Volcker Rule. A similar article appears in today’s American Banker.

Former Federal Reserve Bank of Kansas City President Tom Hoenig, now a director at the FDIC, not only approves of the Volcker Rule, which would curb proprietary trading at commercial banks, but would like to see the largest banks split up in order to separate investment banking from traditional banking. Hoenig has been talking along these lines for quite some time, including at a House subcommittee hearing on Friday. On April 26, he share similar views in Des Moines, telling some 270 bankers that the largest banks should be broken up along six distinct business lines.

“If you look at the largest institutions, there are six lines of business,” he said. “There is the traditional commercial bank. In addition, there is investment banking, there is managing and advising, there are certain kinds of proprietary trading, and broker/dealer activities, and managing investments in trust services.”

Hoenig said the law should segregate these lines of businesses into separate corporations, just as the Glass-Steagall Act separated investment and commercial banking before the Gramm-Leach-Bliley Act was passed in 1999.

Breaking up the largest banks, he said, is not a matter of “getting even,” but a matter of correcting perverse incentives. He said the federal safety net incents the largest institutions to grow and take risks that smaller institutions simply can’t take. Just about the same time Hoenig was making these comments, J.P. Morgan Chase was engaging in highly risky trades that cost $2 billion.

Be sure to read a full report on Hoenig’s April 26 comments in the May 15 edition of NorthWestern Financial Review

Moody’s takes U.S.’s TBTF mitigation efforts seriously

Posted on by
Reply

This Reuters article, which shows up on the Drudge Report today, clearly shows the value of too-big-to-fail status.

People have been talking about too-big-to-fail ever since the Continental Illinois failure in 1984. Smaller banks always said large banks enjoyed a cost of funds advantage because people knew the government would never let them fail. Various studies attempted to show the value of that advantage.

Earlier this year, Kansas City Federal Reserve Bank President Tom Hoenig gave this speech in Washington, D.C., in which he described the advantage:

Andrew Haldane of the Bank of England “estimated that this funding advantage amounted to about $250 billion in 2009 for 28 of the largest banks in the world. At the Federal Reserve Bank of Kansas City, we estimated the ratings and funding advantage for the five largest U.S. banking organizations during this crisis. In June 2009, these organizations had senior, long-term bank debt that was rated four notches higher on average than it would have been based on just the actual condition of the banks, with one bank given an eight notch upgrade for being too-big-to-fail. Looking at the yield curve, this four-notch advantage translates into more than a 160-basis-point savings for debt with two years to maturity and over 360 basis points at seven years to maturity.”

And now, the ratings agencies are proving Hoenig right. Moody’s investors service is downgrading Bank of America, Citibank and Wells Fargo because it says government has shown it is less willing to bail out large banks. The downgrades will have a real economic impact, particularly on Bank of America, which was hit hardest with the downgrade. It will have to pay more to attract bondholders and depositors.

It is interesting to me that the rating agency is taking the too-big-to-fail mitigation provisions in the Dodd-Frank Act seriously. In my opinion, there is still a big question about the political will it would require to actually allow a large troubled bank to fail. Nonetheless, Moody’s action is one more proof that too-big-to-fail is real and puts community banks at a funding disadvantage. Too-big-to-fail is one more way that government picks winners and losers in this economy, and I am glad that we are at least attempting to move away from this damaging policy.

Capital remains the best remedy for TBTF

Posted on by
Reply

There has been a lot of chatter about the need for more capital at the nation’s largest banks. The greater the capital requirements, the less of an issue too-big-to-fail becomes. This is an interesting piece from the New York Times, and if you have a subscription to the Wall Street Journal, be sure to click on the essay’s link to an op-ed piece on the topic in that publication.

Congress could have avoided passing the 800-page single-spaced Dodd-Frank Act if it had instead demanded higher capital from the “systemically important” banks. I argued this point in with this essay that appeared in NorthWestern Financial Review magazine over a year ago. If we are going to allow banks to become enormous, we should demand that they have sufficient capital to protect themselves from their own mistakes.

Most smaller banks are encouraged to maintain capital ratios of 10, 11, even 12 percent. These banks pose no threat to the economy. So why don’t we demand at least something similar in terms of capital reserves, given the significant threat ultra-large banks do pose to the economy?

Here’s what I wrote in February 2010:

Instead of continuing to collectivize risk, the government should force the mega banks to self-insure. The way to do that is to dramatically increase capital requirements, by statute, enough to fully offset the too-big-to-fail subsidy. Currently, to be rated as well-capitalized, banks must hold Tier 1 capital amounting to about 6 percent of assets. For banks (including all the shadow banks and quasi-banks as well) managing more than $100 billion, that figure should be raised certainly to 10 percent and more likely to 12 percent. And all such institutions should be required to be well-capitalized all the time.

People are still proposing variations on this because it’s a good idea.

Fed Pres calls for break-up of biggest banks

Posted on by
Reply

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, delivered quite a speech last week at the Women in Housing and Finance conference conducted in Washington, D.C. Hoenig has long warned about the dangers of too-big-to-fail; now he is saying we have a lot of work remaining to do to solve the problem, despite the passage of the Dodd-Frank Act. Consider these sections from his Feb. 23 speech:

I am convinced that the existence of too big to fail financial institutions poses the greatest risk to the U.S. economy. The incentives for risk-taking have not changed post-crisis and the regulatory factors that helped create the crisis remain in place. We must make the largest institutions more manageable, more competitive, and more accountable. We must break up the largest banks, and could do so by expanding the Volcker Rule and significantly narrowing the scope of institutions that are now more powerful and more of a threat to our capitalistic system than prior to the crisis…

However, one additional option used after the Great Depression still needs to be introduced: Glass-Steagell type limitations on the activities of those organizations that are otherwise too big to fail and that so dramatically affect our national and global economies…

Separate risk taking from the safety net. If too big to fail organizations cannot be effectively supervised, capitalized, or resolved – which is exactly where I contend things stand right now – what option remains?

For me, the answer is firm: they must be broken up. We must not allow organizations operating under the safety net to pursue high-risk activities and we cannot let large organizations put our financial system at risk. Protected institutions must be limited in their risk activities because there is no end to their appetite for risk and no perceived end to the public purse that protects them. As we have seen in this crisis, size and expanded activities have not led to better and more diversified firms as many once argued, but instead have created very large firms with very similar risk profiles that closely mirror the overall financial system and economy.

Read the entire speech here, if you like. Hoenig has been one of the few public officials willing to speak so openly about the significance of the too-big-to-fail problem. I hope someone is listening.

What’s the trade-off for resolving TBTF?

Posted on by
Reply

It’s crunch time in the Senate for financial industry regulatory reform. Sen. Dodd needs to get his bill passed by Memorial Day for a realistic shot at enactment into law this year.

For community bankers, it boils down to this question: Are the TBTF remedies in the legislation compelling enough for community bankers to accept additional regulatory compliance obligations?

Questions will always surround legislative efforts to resolve TBTF “once and for all.” There were a lot of people who thought we solved that problem in 1991 when FDICIA was passed, and clearly it is a bigger problem today than ever.

Resolution authority on TBTF needs to extend beyond the confines of the traditional banking industry so it can address situations like AIG. The House bill and the Dodd bill does, and that’s a good thing. But there will always be this question: Who exactly will qualify as systemically important? Is it just the 19 original TARP recipients? Is it the top 50 holding companies? Who are the non-bank companies that qualify? Who will pay into the pre-paid resolution fund proposed by the House legislation and the Dodd bill? What if a company that never paid into that fund needs special handling? What if the government decides a company that did pay into the fund shouldn’t be treated special?

And how strong will the resolution authority be if the legislation drops the pre-paid resolution fund concept, as apparently is being discussed in the Senate to win support from Republicans? 

Clearly, the largest banks in the country have a cost-of-funds advantage over community banks. But if the law does in fact end TBTF, will community banks make more money as a result of the new, level playing field?

From the perspective of sound public policy, we need to resolve TBTF, but if we do, I am not sure how much that will improve the lot of community bankers. The American taxpayer will benefit from the resolution of TBTF but only community bankers will pay any kind of a price (that is, additional reg burden). Some bankers will say it is worth that price, but I wouldn’t be surprised if some say it isn’t.

Community banks and the OCC

Posted on by
Reply

For as long as I have been covering this industry, bankers have told me that the OCC is really not interested in small banks. “They are focused on the big banks,” I have been told many times. OCC leadership obviously has heard this message and they clearly don’t like it. Many speeches delivered by the Comptroller begin with some clarification about all the community banks under OCC supervision.

“Despite my best efforts, I sometimes still confront the stereotype that the OCC is only concerned about big banks. Let me say again, emphatically, that that’s just not true,” Comptroller John Dugan told community bankers in a speech delivered March 19 in Orlando. He goes on to explain that two-thirds of OCC examiners are focused on community banks. He also noted that the agency reaches out to listen to community bankers through a variety of industry events and meetings. “My over-riding point here is that we at the OCC consider community bank supervision as core to our mission.”

Yet, I wonder whether Mr. Dugan really understands community banking. In the remainder of his speech, he talks about bank failures, emphasizing the disproportionate representation of community banks. “195 banks, nearly all of them community banks, have failed since the start of the crisis in 2008,” he says. Furthermore, he notes an “estimated cost to the deposit insurance fund exceeding $58 billion.”

Any community banker would find that observation a bit galling. Citi and BofA both failed on the OCC’s watch, but Treasury stepped in to prop them up so they were never closed. Had they failed, they would have wiped out the FDIC fund completely. I think it is pretty insensitive to talk to community bankers about the problems in community banking without acknowledging the far more severe problems in a sector of the industry where the OCC has much greater responsibility.

In the speech, Dugan noted four things that he believes regulators need in order to be effective: balanced judgment, to provide appropriate guidance, consistency and forthright engagement with bankers. The irony of his third item — consistency — is inescapable. There is nothing more inconsistent in bank regulation than regulators picking winners and losers. Too-big-to-fail pretty much tells community bankers they are a bunch of losers. Dugan is right to say that one of the most important things regulators can do is be consistent; to me, that means ending too big to fail. Not until this policy is ended will it make any sense to compare community banks with the rest of the industry.

Fed presidents weigh in on TBTF

Posted on by
Reply

Lots of talk about the need to resolve the too-big-to-fail problem in banking at the two big industry pow-wows earlier this month. It was THE topic at the ICBA convention in Orlando, and it was one of the top two industry challenges discussed at the ABA’s Government Relations Summit in Washington, D.C., March 17-18. The other big issue discussed at the ABA meeting was the need to stop reform legislation provisions that would create a new consumer financial protection agency or bureau. (More on that in future posts.) 

ABA brought in several top industry speakers, including a panel of Federal Reserve Bank presidents. Sandra Pianalto of the Cleveland Fed, Jeffrey Lacker of the Richmond Fed and Tom Hoenig of the Kansas City Fed all talked about the need to resolve too big to fail.

“Too big to fail is the central issue that reform needs to face,” Lacker said. He explained that ten years ago, 45 percent of the liabilities in the financial system were perceived to be guaranteed, either implicitly or explicitly, by the federal government. Today, he said, it is 58 percent. While the percentage has increased, the actual percentage of assets with an explicit guarantee has dropped to 22 percent today from 27 percent in 2000, he said.

“We know that too big to fail won’t go away without legislation that brings it under the rule of law,” Hoenig said. Too big to fail results in a “tremendous mis-allocation of resources,” he said. Furthermore, Hoenig explained that too-big-to-fail banks have a cost of funds advantage over community banks. Read Hoenig’s comments here.

While ICBA and ABA agree on the need to resolve too big to fail, they differ on whether the largest banks should be required to pre-fund a pool of money that regulators could use to unwind a systemically important financial institutions that gets into trouble. ICBA wants to see the largest banks put $50 billion into a fund in advance, while ABA argues that pre-paying such a fund only institutionalizes too big to fail. A banker put the question to Pianalto at the ABA summit.

“The issue of the fund, I don’t have a specific answer. The fund would come from those institutions that are too big to fail. The issue is open for discussion,” she said. “If you have an appropriate supervisory structure in place to begin with, then you won’t have to deal with that question.”