Thomas M. Hoenig Vice Chairman
Federal Deposit Insurance Corporation
Presented to the National Association
For
Business Economics 30th Annual Economic
Policy Conference;
Arlington, Virginia
February 24, 2014
The views expressed are those of the author and not necessarily those of the FDIC.
The United States is in its sixth year following the financial and economic crisis of 2008,
and we are just about to start our fourth year since the enactment of the Dodd-Frank
Act. Enormous energy has been expended in an attempt to implement a host of
required reforms. The Volcker Rule has been implemented, and more recently a rule
requiring foreign bank operations to establish U.S. holding companies has been
adopted.
While these are important milestones, much remains undone and I suspect that 2014
will prove to be a critical juncture for determining the future of the banking industry and
the role of regulators within that industry. The inertia around the status quo is a powerful
force, and with the passage of time and fading memories, change becomes ever more
difficult. There are any number of unresolved matters that require attention.
This past July the regulatory authorities proposed a sensible supplemental
capital requirement that is yet to be adopted. This single step would do much to
strengthen the resiliency of the largest banks, since even today they hold
proportionately as little as half the capital of the regional banks. The Global
Capital Index points out that tangible capital to asset levels of the largest firms
average only 4 percent.
The largest banking firms carry an enormous volume of derivatives. The law
directs that such activities be conducted away from the safety net, and we are
still in the process of completing what is referred to as the push-out rules.
Bankruptcy laws have not been amended to address the use of long-term assets
to secure highly volatile short-term wholesale funding. This contributes to a
sizable moral hazard risk among banks and shadow banks, as these instruments
give the impression of being a source of liquidity when, in fact, they are highly
unstable. The response so far has required that we develop ever-more
complicated bank liquidity rules, which are costly to implement and enforce, and
leave other firms free to rely on such volatile funding.
Federal Deposit Insurance Corporation
Presented to the National Association
For
Business Economics 30th Annual Economic
Policy Conference;
Arlington, Virginia
February 24, 2014
The views expressed are those of the author and not necessarily those of the FDIC.
The United States is in its sixth year following the financial and economic crisis of 2008,
and we are just about to start our fourth year since the enactment of the Dodd-Frank
Act. Enormous energy has been expended in an attempt to implement a host of
required reforms. The Volcker Rule has been implemented, and more recently a rule
requiring foreign bank operations to establish U.S. holding companies has been
adopted.
While these are important milestones, much remains undone and I suspect that 2014
will prove to be a critical juncture for determining the future of the banking industry and
the role of regulators within that industry. The inertia around the status quo is a powerful
force, and with the passage of time and fading memories, change becomes ever more
difficult. There are any number of unresolved matters that require attention.
This past July the regulatory authorities proposed a sensible supplemental
capital requirement that is yet to be adopted. This single step would do much to
strengthen the resiliency of the largest banks, since even today they hold
proportionately as little as half the capital of the regional banks. The Global
Capital Index points out that tangible capital to asset levels of the largest firms
average only 4 percent.
The largest banking firms carry an enormous volume of derivatives. The law
directs that such activities be conducted away from the safety net, and we are
still in the process of completing what is referred to as the push-out rules.
Bankruptcy laws have not been amended to address the use of long-term assets
to secure highly volatile short-term wholesale funding. This contributes to a
sizable moral hazard risk among banks and shadow banks, as these instruments
give the impression of being a source of liquidity when, in fact, they are highly
unstable. The response so far has required that we develop ever-more
complicated bank liquidity rules, which are costly to implement and enforce, and
leave other firms free to rely on such volatile funding.
Fannie Mae and Freddie Mac continue to operate under government
conservatorship, and as such they dominant home mortgage financing in the
United States.
Finally, among the more notable and difficult pieces of the unfinished business is
the assignment to assure that the largest, most complicated banks can be
resolved through bankruptcy in an orderly fashion and without public aid.
Congress gave the Federal Reserve and the FDIC, and the relevant banking
companies, a tough assignment under the Title 1 provisions of the Dodd-Frank
Act to solve this problem. It requires making difficult decisions now, or the die will
be cast and the largest banking firms will be assured an advantage that few
competitors will successfully overcome1.
The Persistence of Too Big To Fail
I want to spend a few more minutes on this last topic, as it remains a critical step to a
more sound financial system.
The chart titled Consolidation of the Credit Channel shows the trend in concentration of
financial assets since 1984. The graph shows the distribution of assets for four groups
of banks, ranging in size from less than $100 million to more than $10 billion. The chart
shows that in 1984, the control of assets among the different bank groups was almost
proportional. Also, within each group if a single bank failed, even the largest, it might
shock the economy, but most likely would not bring it down. Today this distribution of
assets is dramatically different. Banks controlling assets of more than $10 billion have
come to compose an overwhelming proportion of the economy, and those with more
than a trillion dollars in assets have come to dominate this group. If even one of the
largest five banks were to fail, it would devastate markets and the economy.
Title I of the Dodd-Frank Act is intended to address this issue by requiring these largest
firms to map out a bankruptcy strategy. This is referred to as the Living Will. If
bankruptcy fails to work, Title II of Dodd-Frank would have the government nationalize
and ultimately liquidate a failing systemic firm.
While these mechanisms outline a path for resolution, success will be determined by
how manageable large and complex firms are under bankruptcy and whether under any
circumstance they can be resolved without major disruption to the economy. This is a
daunting task, and increasing numbers of experts question whether it can be done given
current industry structure.2 Two impediments are most often highlighted to organizing
an orderly bankruptcy or liquidation for these firms.
First, it is not possible for the private sector to provide the necessary liquidity through
"debtor in possession" financing due to the size and complexity of the institutions and
due to the speed at which crises occur. There simply would be too little confidence in
bank assets and the lender's ability to be repaid, and too little time to unwind these firms
in an orderly fashion in a bankruptcy. Under the current system, it would have to be the
conservatorship, and as such they dominant home mortgage financing in the
United States.
Finally, among the more notable and difficult pieces of the unfinished business is
the assignment to assure that the largest, most complicated banks can be
resolved through bankruptcy in an orderly fashion and without public aid.
Congress gave the Federal Reserve and the FDIC, and the relevant banking
companies, a tough assignment under the Title 1 provisions of the Dodd-Frank
Act to solve this problem. It requires making difficult decisions now, or the die will
be cast and the largest banking firms will be assured an advantage that few
competitors will successfully overcome1.
The Persistence of Too Big To Fail
I want to spend a few more minutes on this last topic, as it remains a critical step to a
more sound financial system.
The chart titled Consolidation of the Credit Channel shows the trend in concentration of
financial assets since 1984. The graph shows the distribution of assets for four groups
of banks, ranging in size from less than $100 million to more than $10 billion. The chart
shows that in 1984, the control of assets among the different bank groups was almost
proportional. Also, within each group if a single bank failed, even the largest, it might
shock the economy, but most likely would not bring it down. Today this distribution of
assets is dramatically different. Banks controlling assets of more than $10 billion have
come to compose an overwhelming proportion of the economy, and those with more
than a trillion dollars in assets have come to dominate this group. If even one of the
largest five banks were to fail, it would devastate markets and the economy.
Title I of the Dodd-Frank Act is intended to address this issue by requiring these largest
firms to map out a bankruptcy strategy. This is referred to as the Living Will. If
bankruptcy fails to work, Title II of Dodd-Frank would have the government nationalize
and ultimately liquidate a failing systemic firm.
While these mechanisms outline a path for resolution, success will be determined by
how manageable large and complex firms are under bankruptcy and whether under any
circumstance they can be resolved without major disruption to the economy. This is a
daunting task, and increasing numbers of experts question whether it can be done given
current industry structure.2 Two impediments are most often highlighted to organizing
an orderly bankruptcy or liquidation for these firms.
First, it is not possible for the private sector to provide the necessary liquidity through
"debtor in possession" financing due to the size and complexity of the institutions and
due to the speed at which crises occur. There simply would be too little confidence in
bank assets and the lender's ability to be repaid, and too little time to unwind these firms
in an orderly fashion in a bankruptcy. Under the current system, it would have to be the