Statement of
Thomas M. Hoenig
On
Avoiding Taxpaper Funded Bailouts
By
Returning to Free Enterprise
And
Pro Growth Bank Regulatory Policies
before the
Committee On Financial Services,
United States House of Representatives;
2128 Rayburn House
Office Building
June 26, 2013
The views expressed by the author are his own and do not necessarily reflect those of
the Federal Deposit Insurance Corporation, its directors, officers or representatives.
Chairman Hensarling, Ranking Member Waters and Members of the Committee, I
appreciate the opportunity to testify on issues relating to improving the safety and
soundness of our nation's banking system. How policymakers and regulators choose to
structure the financial system to allocate the use of the government's facilities and
subsidy will define the long-run stability and success of the U.S. economy. My testimony
today is based on a paper, titled "Restructuring the Banking System to Improve Safety
and Soundness," that I prepared with my colleague Chuck Morris in May 2011. I
welcome this opportunity to explain the pro-growth and pro-competition
recommendations for the financial system in the paper, which I have attached to this
testimony (Attachment 1). Although I am a board member of the FDIC, I speak only for
myself today.
Too Important to Fail
Almost three years after passage of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act), an issue that remains critical to the long-run stability of
our financial and economic system is the degree to which the government should
subsidize and therefore facilitate ever-greater risk taking among our most dominant
financial firms. These firms by their very size and complexity affect the broader
economy to an overwhelming degree; and since the recent financial crisis, they have
only become more influential and the economy more dependent on their performance.
The largest U.S. financial holding company has nearly $2.4 trillion of assets under
GAAP accounting, which is equivalent to 15 percent of nominal GDP. If we take into
account the gross fair value of its derivative book, it has nearly $4 trillion of assets,
equivalent to 25 percent of nominal GDP. The largest eight U.S. global systemically
important financial institutions in tandem hold $10 trillion of assets under GAAP
Thomas M. Hoenig
On
Avoiding Taxpaper Funded Bailouts
By
Returning to Free Enterprise
And
Pro Growth Bank Regulatory Policies
before the
Committee On Financial Services,
United States House of Representatives;
2128 Rayburn House
Office Building
June 26, 2013
The views expressed by the author are his own and do not necessarily reflect those of
the Federal Deposit Insurance Corporation, its directors, officers or representatives.
Chairman Hensarling, Ranking Member Waters and Members of the Committee, I
appreciate the opportunity to testify on issues relating to improving the safety and
soundness of our nation's banking system. How policymakers and regulators choose to
structure the financial system to allocate the use of the government's facilities and
subsidy will define the long-run stability and success of the U.S. economy. My testimony
today is based on a paper, titled "Restructuring the Banking System to Improve Safety
and Soundness," that I prepared with my colleague Chuck Morris in May 2011. I
welcome this opportunity to explain the pro-growth and pro-competition
recommendations for the financial system in the paper, which I have attached to this
testimony (Attachment 1). Although I am a board member of the FDIC, I speak only for
myself today.
Too Important to Fail
Almost three years after passage of the Dodd-Frank Wall Street Reform and Consumer
Protection Act (Dodd-Frank Act), an issue that remains critical to the long-run stability of
our financial and economic system is the degree to which the government should
subsidize and therefore facilitate ever-greater risk taking among our most dominant
financial firms. These firms by their very size and complexity affect the broader
economy to an overwhelming degree; and since the recent financial crisis, they have
only become more influential and the economy more dependent on their performance.
The largest U.S. financial holding company has nearly $2.4 trillion of assets under
GAAP accounting, which is equivalent to 15 percent of nominal GDP. If we take into
account the gross fair value of its derivative book, it has nearly $4 trillion of assets,
equivalent to 25 percent of nominal GDP. The largest eight U.S. global systemically
important financial institutions in tandem hold $10 trillion of assets under GAAP
accounting, or the equivalent of two-thirds of U.S. GDP, and $16 trillion of assets when
including the gross fair value of derivatives, which is the equivalent of 100 percent of
GDP.
My concern with the largest financial institutions is not only their size but their
complexity and the subsidy that facilitates each. Over time, the government's safety net
of deposit insurance, Federal Reserve lending and direct investment has been
expanded to an ever-broader array of activities outside the historic role of commercial
banks -- transforming short-term deposits into long-term loans and operating the
payments system that transfers money around the country and the world. In the U.S.,
the Gramm-Leach-Bliley Act allowed commercial banks to engage in a host of broker-
dealer activities, including proprietary trading, derivatives and swaps activities -- all
within the federal safety net. Following passage of this Act, in order to compete with
subsidized firms, broker-dealers found it necessary to either merge with commercial
banks or change their business model by taking on dramatically greater debt and risk.
For example, firms like Bear Stearns began to borrow short to lend long and to engage
in other bank-like activities. As they increased in size and complexity, the markets
correctly assumed that the safety net would extend to these firms. Therefore, institutions
engaged in banking activities significantly contributed to the crisis whether they were
called "banks" at the time or not.
Even today, following enactment of the Dodd-Frank Act, government support of these
dominant firms, explicit and implied, combined with their outsized impact on the broader
economy, gives them important advantages and encourages them to take on ever-
greater degrees of risk. Short-term depositors and creditors continue to look to
governments to assure repayment rather than to the strength of the firms' balance
sheets and capital. As a result, these companies are able to borrow more at lower costs
than they otherwise could, and thus they are able increase their leverage far beyond
what the market would otherwise permit. Their relative lower cost of capital also enables
them to price their products more favorably than firms outside of the safety net can do.
For your information, I have included with my testimony a chart (Attachment 2) that
shows current leverage ratios for some of the world's largest financial firms. History tells
us that without the safety net, the market would have allowed far less leverage.
The Subsidy
The advantages I describe above translate into a subsidy that represents a sizable
competitive advantage and which leads to a more concentrated industry. A large and
growing body of evidence supports the existence of such a subsidy. A summary of
studies is included with my written testimony (Attachment 3). While the estimated size of
the subsidy may vary in degree, depending on the methodology, nearly all independent
studies calculate the value to be in the billions of dollars. This government subsidy
facilitates these firms' growth beyond what economies of size and scope can otherwise
justify and subjects the broader economy to the adverse effects of management
misjudgments, which in turn entrenches the behavior of repeated financial bailouts
within modern economies.
including the gross fair value of derivatives, which is the equivalent of 100 percent of
GDP.
My concern with the largest financial institutions is not only their size but their
complexity and the subsidy that facilitates each. Over time, the government's safety net
of deposit insurance, Federal Reserve lending and direct investment has been
expanded to an ever-broader array of activities outside the historic role of commercial
banks -- transforming short-term deposits into long-term loans and operating the
payments system that transfers money around the country and the world. In the U.S.,
the Gramm-Leach-Bliley Act allowed commercial banks to engage in a host of broker-
dealer activities, including proprietary trading, derivatives and swaps activities -- all
within the federal safety net. Following passage of this Act, in order to compete with
subsidized firms, broker-dealers found it necessary to either merge with commercial
banks or change their business model by taking on dramatically greater debt and risk.
For example, firms like Bear Stearns began to borrow short to lend long and to engage
in other bank-like activities. As they increased in size and complexity, the markets
correctly assumed that the safety net would extend to these firms. Therefore, institutions
engaged in banking activities significantly contributed to the crisis whether they were
called "banks" at the time or not.
Even today, following enactment of the Dodd-Frank Act, government support of these
dominant firms, explicit and implied, combined with their outsized impact on the broader
economy, gives them important advantages and encourages them to take on ever-
greater degrees of risk. Short-term depositors and creditors continue to look to
governments to assure repayment rather than to the strength of the firms' balance
sheets and capital. As a result, these companies are able to borrow more at lower costs
than they otherwise could, and thus they are able increase their leverage far beyond
what the market would otherwise permit. Their relative lower cost of capital also enables
them to price their products more favorably than firms outside of the safety net can do.
For your information, I have included with my testimony a chart (Attachment 2) that
shows current leverage ratios for some of the world's largest financial firms. History tells
us that without the safety net, the market would have allowed far less leverage.
The Subsidy
The advantages I describe above translate into a subsidy that represents a sizable
competitive advantage and which leads to a more concentrated industry. A large and
growing body of evidence supports the existence of such a subsidy. A summary of
studies is included with my written testimony (Attachment 3). While the estimated size of
the subsidy may vary in degree, depending on the methodology, nearly all independent
studies calculate the value to be in the billions of dollars. This government subsidy
facilitates these firms' growth beyond what economies of size and scope can otherwise
justify and subjects the broader economy to the adverse effects of management
misjudgments, which in turn entrenches the behavior of repeated financial bailouts
within modern economies.