"Finding the Right Balance"
Keynote speech by FDIC Vice Chairman Thomas M. Hoenig presented to
the Peterson Institute for International Economics in Washington, DC
March 28, 2018
Introduction
Over Fourth of July weekend in 1982, I was the officer in charge of lending at the
Federal Reserve Bank of Kansas City. Our week had begun with “the phone call” from a
panicked banker whose institution was experiencing a serious liquidity problem. The
bank’s funding sources, mostly deposits and upstream purchasers of its energy loans,
had lost confidence and were running. Then, reminiscent of a scene from the Great
Depression, lines had formed outside the bank as depositors demanded their money
back, having heard rumors that the institution was in trouble. The Reserve Bank
provided some replacement funding through its discount operations with the goal of
buying time to determine whether the bank was solvent and, if so, whether it had
sufficient collateral to lend against. Ultimately, the bank, Penn Square National Bank,
met neither test. It had too little capital and its assets were too distressed to offer any
hope of survival. The bank was closed that holiday weekend.
In the end, Penn Square, through its model of originate to distribute, contributed to the
largest bank failure in U.S. history at the time with the collapse of Continental Illinois
National Bank. However, because Continental was then the fifth-largest U.S. bank and
because numerous creditors would have taken significant losses if it had failed,
regulators chose to bail it out. Thus began Too Big to Fail as a policy option in the United
States.
I tell this story because it illustrates just how little has changed over the past almost 40
years. Events since then have included the S & L crisis, the Mexican Peso crisis, the Asian
financial crisis, the Russian financial crisis and failure of Long-Term Capital Management,
and, of course, the Great Recession and the Greek sovereign debt crisis. Each crisis has
its own personality but what is often ignored is that the fundamental elements almost
never change.
The elements include a significant change in monetary policy—a crucial but inherently
blunt instrument with far-reaching effects; a significant ramping up of leveraged assets;
and management that displays a degree of confidence that repeatedly proves
unjustified. On the other side, they too often include supervisors who lack the
confidence or are so convinced of management’s talents that they fail to challenge
Keynote speech by FDIC Vice Chairman Thomas M. Hoenig presented to
the Peterson Institute for International Economics in Washington, DC
March 28, 2018
Introduction
Over Fourth of July weekend in 1982, I was the officer in charge of lending at the
Federal Reserve Bank of Kansas City. Our week had begun with “the phone call” from a
panicked banker whose institution was experiencing a serious liquidity problem. The
bank’s funding sources, mostly deposits and upstream purchasers of its energy loans,
had lost confidence and were running. Then, reminiscent of a scene from the Great
Depression, lines had formed outside the bank as depositors demanded their money
back, having heard rumors that the institution was in trouble. The Reserve Bank
provided some replacement funding through its discount operations with the goal of
buying time to determine whether the bank was solvent and, if so, whether it had
sufficient collateral to lend against. Ultimately, the bank, Penn Square National Bank,
met neither test. It had too little capital and its assets were too distressed to offer any
hope of survival. The bank was closed that holiday weekend.
In the end, Penn Square, through its model of originate to distribute, contributed to the
largest bank failure in U.S. history at the time with the collapse of Continental Illinois
National Bank. However, because Continental was then the fifth-largest U.S. bank and
because numerous creditors would have taken significant losses if it had failed,
regulators chose to bail it out. Thus began Too Big to Fail as a policy option in the United
States.
I tell this story because it illustrates just how little has changed over the past almost 40
years. Events since then have included the S & L crisis, the Mexican Peso crisis, the Asian
financial crisis, the Russian financial crisis and failure of Long-Term Capital Management,
and, of course, the Great Recession and the Greek sovereign debt crisis. Each crisis has
its own personality but what is often ignored is that the fundamental elements almost
never change.
The elements include a significant change in monetary policy—a crucial but inherently
blunt instrument with far-reaching effects; a significant ramping up of leveraged assets;
and management that displays a degree of confidence that repeatedly proves
unjustified. On the other side, they too often include supervisors who lack the
confidence or are so convinced of management’s talents that they fail to challenge
questionable executive behavior.
Another common element of most crises is the aftermath, in which new laws and
regulations are enacted with the intent to prevent new crises. But memories are short
and with an improving economy, these laws and regulations—which early in the
recovery are viewed as essential—are eventually recast as burdensome constraints that
need to be eased or ended.
And here we are again. After years of slow recovery, the U.S. economy is booming and
the call for regulatory relief is loud. This is the case despite changing monetary policy,
increasingly volatile markets, increasing economic leverage, and changing risk profiles of
some of our largest institutions. Still, standards of living are on the rise. Indeed, U.S.
gross domestic product (GDP) is projected to approach a 3 percent growth rate this
year. While in flux, both monetary and fiscal policy are accommodative. As you would
expect, the banking industry is an important part of this success, generating $165 billion
of income in 2017, a near record high.
Considering this history, I want to take this opportunity, as I step away from my role at
the FDIC, to outline an approach for providing meaningful regulatory relief without
undermining the goal of assuring sound banking. The recommendations are founded on
my confidence in markets and in their ability to deliver consistent economic growth. But
there is a trade-off. Success requires that the rules which remain to assure that markets
work include proven prudential standards that are enforced rigorously and complied
with consistently. These standards include strong capital and wise constraints on a
bank’s reliance on the government’s safety net. With such a foundation in place, a
number of costly administrative rules that create burden with little benefit can be
removed or minimized.
Prudential Standards and Success
Today, the U.S. banking industry is better capitalized than that of most other major
industrial countries.i Better capitalized banks lend more, promote economic growth and
financial stability, and provide the necessary confidence for the world to invest in them.
In fact, throughout the modern era, the United States has fostered and sustained a
strong and highly influential banking system that is the envy of the world. From this
strength, U.S. banks are again reporting near-record profits.
As bank profits have grown, so too have their appetite for risk and their dislike for
regulations that constrain that appetite. They also are frustrated with rules that impose
thousands of pages of administrative processes and unproductive costs onto their
operations. The challenge is to eliminate those rules that impose a real administrative
burden from those that set performance standards that allow properly gauged and
priced risks onto the balance sheet. The former rules create needless barriers to bank
competition and fall disproportionately on the different segments of the industry, while
Another common element of most crises is the aftermath, in which new laws and
regulations are enacted with the intent to prevent new crises. But memories are short
and with an improving economy, these laws and regulations—which early in the
recovery are viewed as essential—are eventually recast as burdensome constraints that
need to be eased or ended.
And here we are again. After years of slow recovery, the U.S. economy is booming and
the call for regulatory relief is loud. This is the case despite changing monetary policy,
increasingly volatile markets, increasing economic leverage, and changing risk profiles of
some of our largest institutions. Still, standards of living are on the rise. Indeed, U.S.
gross domestic product (GDP) is projected to approach a 3 percent growth rate this
year. While in flux, both monetary and fiscal policy are accommodative. As you would
expect, the banking industry is an important part of this success, generating $165 billion
of income in 2017, a near record high.
Considering this history, I want to take this opportunity, as I step away from my role at
the FDIC, to outline an approach for providing meaningful regulatory relief without
undermining the goal of assuring sound banking. The recommendations are founded on
my confidence in markets and in their ability to deliver consistent economic growth. But
there is a trade-off. Success requires that the rules which remain to assure that markets
work include proven prudential standards that are enforced rigorously and complied
with consistently. These standards include strong capital and wise constraints on a
bank’s reliance on the government’s safety net. With such a foundation in place, a
number of costly administrative rules that create burden with little benefit can be
removed or minimized.
Prudential Standards and Success
Today, the U.S. banking industry is better capitalized than that of most other major
industrial countries.i Better capitalized banks lend more, promote economic growth and
financial stability, and provide the necessary confidence for the world to invest in them.
In fact, throughout the modern era, the United States has fostered and sustained a
strong and highly influential banking system that is the envy of the world. From this
strength, U.S. banks are again reporting near-record profits.
As bank profits have grown, so too have their appetite for risk and their dislike for
regulations that constrain that appetite. They also are frustrated with rules that impose
thousands of pages of administrative processes and unproductive costs onto their
operations. The challenge is to eliminate those rules that impose a real administrative
burden from those that set performance standards that allow properly gauged and
priced risks onto the balance sheet. The former rules create needless barriers to bank
competition and fall disproportionately on the different segments of the industry, while