Does DFA Fail on Too Big to Fail? (Feb. 17)

Mike & Co.  —

The newly-installed the Minneapolis Federal Reserve Bank and former Special Investigator overseeing the TARP program came to town yesterday advocating drastic action to head off a financial sector systemic risk crisis, calling for the nation’s biggest banks to be broken up. 

His speech, delivered at Brookings, got noticed, with lengthy coverage in the NYT, WSJ, and WaPo.  And perhaps with reason — the TBTF (too big to fail) issue has dogged Congress and the administration for years and is one of the central ones in the Democratic presidential campaign this far. 

Or maybe it was just a slow news day.  You decide…




A Peculiar Package of Proposals

Kashkari argued in the alternative that Dodd-Frank needs to be used and/or needs to be reformed.  He says the law as written does not solve the TBTF problem.  He also wants regulators to use the yet-untried tools at their disposal under the law.   “While significant progress has been made to strengthen our financial system, I believe the [Dodd-Frank] Act did not go far enough.”  He then laid out three ideas meant to end TBTF once and for all.

  •  break up large banks into smaller, less connected, less important entities;
  •  turn what remains of the large banks into public utilities by forcing them to hold so much capital that they can’t fail; and
  •  tax leverage throughout the financial system “to reduce systemic risks wherever they lie.”
  •  Break up the Banks

From the perspective of current laws, breaking up big banks is already a policy avenue available to regulators.  The Federal Reserve, through the Financial Stability Oversight Council, can elect to take a number of actions to deal with banks that it feels are both systemically important and organized in an unstable way.  Section 121 of the Dodd-Frank Act gives the Board of Governors these powers.

So this first proposal – break up big banks – has been covered here before but just for the sake of argument… which banks need to be broken up most urgently?  Few commentators believe there is an imminent threat demanding action.

Unsurprisingly, the Fed doesn’t believe that banks are so hopeless that they need to be dissolved.  That doesn’t mean it’s not a possibility under current legislation, however.

  •   Make Banks “Utilities”

The second proposal is to push capital requirements for banks so high that they “essentially turn into public utilities.”  Kashkari never explains how exactly high capital reserves turn banks into utilities, but that’s for another time.

He is voicing his support for one of the oldest forms of banking regulations that we still use and use far more now in the Dodd-Frank era – he wants banks to hold more capital.  Supporters of the law may be heartened by his full-throated endorsement of the law on this score.

  •   Cribbing from Clinton?

The third proposal was just about lifted out of Secretary Clinton’s plan to regulate Wall Street –- though the reporting on the speech doesn’t much mention it much.  It is reasonable both from a policy and a political perspective. But he doesn’t provide further details about his proposal after first outlining it.

Kashkari contra Yellen

Fed Chair Yellen has been an outspoken proponent of existing banking regulations, making it known that while the job of regulators is not done yet. we’re in a much better situation now than we were before DFA.  During her testimony before House Financial Services, Yellen fielded a question about why she had not yet broken up big banks, saying: “…we [at the Fed]vare using our powers to make sure that a systemically important institution could fail, and it would not be — have systemic consequences for the country. We’re doing that in a whole variety of ways.”

The ways Yellen is referring to include enforcing Liquidity Coverage Ratios, capital reserve requirements, and a rule passed last November forcing the biggest banks to issue long-term debt equal to 18 percent of risk-weighted assets.

Evidently it’s not enough.  But it is nonetheless uncommon for a newly minted Federal Reserve Bank President to taking to task the Chair of the Federal Reserve’s Board of Governors.

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