Tags: Hoenig | FDIC | bank | capital

FDIC Leader Calls for Better Research on Banking

By    |   Wednesday, 01 October 2014 08:09 AM

The FDIC held its annual two-day bank research conference Sept. 18 and 19 at its facility in northern Virginia, where the theme was "Risk Management After the Crisis: What is next for the domestic and international financial institutions and systems?"

Unfortunately whoever chose this title made the common mistake of using the expression "after the crisis" without realizing that the "crisis" goes back four or five decades and that no end is in sight, because the largest financial institutions are still in shaky condition, the seriousness of which is unknown to the so-called "prudential regulators" and nothing has ever been done to stop these risky, troubled institutions from continuing to grow on shaky or nonexistent capital bases.

One person who clearly does realize this and who has been talking about it to just about any audience that will listen is Thomas Hoenig, now vice chairman of the FDIC and former president of the Federal Reserve Bank of Kansas City. On his way up the ladder during his 38-year career with the Fed, Hoenig served as an economist and head of the Division of Bank Supervision and Structure.

Hoenig made the luncheon speech on the first day, which apparently he does annually. This writer was wondering whether to expect a policy speech or a research speech, but Hoenig provided both as he listed a number of glaring misconceptions that are propagated in the discourse concerning the financial crisis. He then urged his audience of researchers to focus their work on improving the analysis of these issues, with the hope that their findings could spur better policy outcomes.

At the outset Hoenig repeated his consistent message, which coincidentally is the same one this writer attempted to convey to the Reagan transition in 1981, that this country is afflicted by a circumstance in which any one of the largest banks can fail and bring the economy to a standstill.

He then listed some tenets held by mainstream regulators and commentators that he disputes:
  1. Liquidity as the problem. Hoenig argued that too much emphasis is placed on liquidity when the main issue is the potential for market participants to lose confidence in the solvency of the largest banks. This can happen for good reason because they don't have enough capital and they need to prove that their capital is good. He concluded that liquidity problems are a consequence of insolvency, not a cause.
  2. Blaming shadow banks. Hoenig disagreed with the commonly held view that the 2008 crisis episode was cause by so-called unregulated "shadow banks." Rather, he contends that the government-sponsored enterprises (GSEs) were able to do the damage they did because they were able to operate under "a cloak of regulation that allowed increased leverage."
  3. "Too big to fail" subsidy no longer exists. Hoenig disagreed with the position of some authorities, recently presented by the Government Accountability Office to the Senate Banking Committee, that the subsidy provided by the government to the largest banks has mostly been eliminated. He finds that it is "still there and would balloon in another crisis."
  4. Too big to fail banks have doubled their capital. Hoenig ridiculed this widely disseminated assertion, quipping that twice 1 percent is still only 2 percent, and that twice 2 percent is still only 4 percent and still inadequate. He urged that banks that seek returns appropriate to hedge funds put up commensurate capital close to 15 percent that would hold up throughout the business cycle, and he called the determination of the appropriate capital levels "a fertile area for research."
  5. Stronger capital requirements would slow growth. Hoenig pointed out that liquidity and leverage are confused, but banks that had higher capital than the largest banks were better able to retain their assets under stress.
  6. Too big to fail banks cannot be resolved through bankruptcy. Hoenig disputed that this is inevitable, and he urged the legal, financial and economics communities to work toward applying to banking the same bankruptcy principles that apply to other industries or else repeal the resolution provisions of Dodd-Frank and admit that the too big to fail banks are in fact GSEs.
(The agenda from the FDIC's annual bank research conference can be found here.)

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The FDIC held its annual two-day bank research conference Sept. 18 and 19 at its facility in northern Virginia, where the theme was "Risk Management After the Crisis: What is next for the domestic and international financial institutions and systems?"
Hoenig, FDIC, bank, capital
Wednesday, 01 October 2014 08:09 AM
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