Richard Fisher and Harvey Rosenblum, president and research director respectively of the Dallas Fed, offer their prescription for mitigating the risk of banks that are “too big to fail”:
First, we would roll back the federal safety net—deposit insurance and the Federal Reserve’s discount window—to apply only to traditional commercial banks, and not to the nonbank affiliates of bank holding companies or the parent companies themselves, where the safety net was never intended to be.
Second, customers, creditors and counterparties of all nonbank affiliates and the parent holding companies would sign a simple, legally binding, unambiguous disclosure acknowledging and accepting that there is no government guarantee—ever—backstopping their investment. A similar disclaimer would apply to bank deposits outside the FDIC insurance limit and other unsecured debts.
Third, we recommend that the largest financial holding companies be restructured so that every one of their corporate entities is subject to a speedy bankruptcy process, and in the case of banking entities themselves, that they be of a size that is “too small to save.” Addressing institutional size is vital to maintaining a credible threat of failure, thereby providing a convincing case that policy has truly changed. This step gets both bank incentives and structure right, neither of which is accomplished by Dodd–Frank.
I think the first two prescriptions are boilerplate. The root of the problem is that whatever the laws the institutions are seen as too big to allow to fail. “Don’t do that” isn’t enough of a prescription.
The third, unfortunately, is just wishful thinking. It can be stated more succinctly as “Just do it!”. It presupposes that breaking up the elephantine big banks into chewable pieces is a shared goal. Quite to the contrary, if the big banks are broken up and rendered small enough to be allowed to fail where will politicians and apparatchiks go to rake in the big bucks after (or between) their period of what we laughingly refer to as “public service”?
Yes, the first two are boilerplate, but they still should be done.
As for the third, although the lament is correct, it is a “vignette” on why my small-governemnt-so-they-don’t-meddle worldview is correct. But as long as we have the steves, Michaels and sams of the world refusing to acknowledge this reality we will probably end up with another more government regulation nightmare story: Son of Dodd-Frank, starring preening politicians and a box office hit courtesy of their adoring fans.
To paraphrase the gun control-ists……if I could just change one mind.
Son of Dodd-Frank, starring preening politicians and a box office hit courtesy of their adoring fans.
First my morning coffee to wake up, then my 1st laugh to mellow the day. Thanks Drew.
If only there were some proof that a small govt cannot meddle.
On topic, I think we need to break them up, but we also need some way to let them fail. No one knows how to take an international bank through BK proceedings. Whose laws apply? It was very clear from the recent bank failures that the banks did not know how to corral and liquidate their complex financial products. The one thing Dodd-Frank definitely got correct was requiring every big bank to have a living will.
That said, that still leaves the problem of group think. If all of the banks, like in the 2000s, decide asset prices cannot fall, we can still end up in the same place.
Steve
@steve
These guys are hustlers. They need you to believe they cannot unravel these instruments.
The financial guys were counting on the CDS’s to insulate their investments from the asset prices.
I would add regulating derivatives similar to commodity futures and raise capital requirements.