Tags: GAO | bank | Brown-Vitter | capital

GAO and Star Professors Look at Bank Holding Companies — Part II

By    |   Tuesday, 14 Jan 2014 06:40 AM

On Jan. 8, the Senate Banking Committee's Subcommittee on Financial Institutions and Consumer Protection, chaired by Sherrod Brown, D-Ohio, held a hearing on "Examining the GAO [Government Accountability Office] Report on Government Support for Bank Holding Companies."

Monday's article
discussed the testimony of Lawrance Evans, director of financial markets and community investment at the GAO.

Today's follow-up will set forth highlights of the testimony of the distinguished economists who followed Evans and will list suggestions they offered for possible reform legislation.

Luigi Zingales, a professor of entrepreneurship and finance at the University of Chicago who has recently been engaged by the Public Company Accounting Oversight Board to run an in-house think tank, called for regulators to apply so-called Prompt Corrective Action, which would require weak financial institutions to shore up their capital or face enforcement action.

I made a similar suggestion to the Reagan transition in 1981 as a way of addressing the insolvency of some of the nation's largest financial institutions — Citibank, Chase, Bank of America, Fannie Mae and Freddie Mac — and warned that the consequence of failure to do so could be a serious and costly recession much like the one that has in fact taken place.

By the end of the decade, public outrage over the wave of savings and loan failures led to the enactment of two landmark bills — the Financial Institutions Reform, Recovery and Enforcement Act of 1989 and the Federal Deposit Insurance Corporation Improvement Act of 1991, that were supposed to ensure such failures could "never happen again."

Instead, industry and congressional opposition and the failure to implement the legislation led directly to the 2008 episode of the ongoing financial crisis, which the Treasury, the Fed and the other hapless, feckless regulators claim no one could have predicted and took them completely by surprise. The largest, riskiest financial institutions have grown even bigger in the meantime.

Simon Johnson, a professor at MIT, found seven faults with the GAO report, most serious of which was its failure to discount "expert" opinion when it is sponsored by the banking lobby. He endorsed the Brown-Vitter bill to scale back the risk posed by the biggest banks and called for the Federal Reserve to fill the vacant position of vice chairman for supervision.

Harvey Rosenblum, former director of research at the Federal Reserve Bank of Dallas, estimated that when all the costs of the 2008 episode are added up, they would reach $15 trillion to $30 trillion, up to twice the annual GDP of the United States. He argued that the large subsidy the government provides to the "too big to fail" banks undermines corporate governance at the banks and operates as a disincentive to downsize these institutions.

The Dallas Fed has been promoting a plan that would 1) limit the federal safety net to traditional banking activities, 2) require customers of nonbanks to acknowledge that they will not be eligible for bailouts and 3) encourage managements to downsize their bank holding companies. He also backs a proposal by Boston University Professor Cornelius Hurley to "lock up" subsidies to banks so that they can't be distributed or wasted.

Finally, Allan Meltzer, a professor at Carnegie Mellon University, returned to the basic principle that while there is a public responsibility to protect the payments system, this does not extend to protecting banks or bankers. He supports the Brown-Vitter proposal to require 15 percent capital and would suspend dividends and bonuses whenever capital falls below 10 percent.

(Archived video and statements of witnesses can be found here.)

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Robert-Feinberg
On Jan. 8, the Senate Banking Committee's Subcommittee on Financial Institutions and Consumer Protection, chaired by Sherrod Brown, D-Ohio, held a hearing on "Examining the GAO [Government Accountability Office] Report on Government Support for Bank Holding Companies."
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Tuesday, 14 Jan 2014 06:40 AM
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