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Dallas Fed President: Time for Congress to Break up the Big Banks

Richard Fisher, president of the Dallas Fed, has been a proponent of breaking up America’s biggest banks and ending Too Big To Fail. In a speech yesterday, he floated a plan on how to do it.

1. Under our proposal, only the commercial bank would have access to deposit insurance provided by the FDIC and discount window loans provided by the Federal Reserve. These two features of the safety net would explicitly, by statute, become unavailable to any shadow banking affiliate, special investment vehicle of the commercial bank or any obligations of the parent holding company. This is largely the current case—but in theory, not in practice. And consistent enforcement is viewed as unlikely.

2. To reinforce the statute and its credibility, every customer, creditor and counterparty of every shadow banking affiliate and of the senior holding company would be required to agree to and sign a new covenant, a simple disclosure statement that acknowledges their unprotected status.

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3.  This two-part step should begin to remove the implicit TBTF subsidy provided to BHCs and their shadow banking operations. Entities other than commercial banks have inappropriately benefited from an implicit safety net. Our proposal promotes competition in light of market and regulatory discipline, replacing the status quo of subsidized and perverse incentives to take excessive risk.

As indicated earlier, some government intervention may be necessary to accelerate the imposition of effective market discipline. We believe that market forces should be relied upon as much as practicable. However, entrenched oligopoly forces, in combination with customer inertia, will likely only be overcome through government-sanctioned reorganization and restructuring of the TBTF BHCs. A subsidy once given is nearly impossible to take away. Thus, it appears we may need a push, using as little government intervention as possible to realign incentives, reestablish a competitive landscape and level the playing field.

But wait, doesn’t Dodd-Frank already solve this problem? Under the law’s Orderly Liquidation Authority, as Fisher explains, a systemically-important financial institution “would receive debtor-in-possession financing from the US Treasury over the period its operations needed to be stabilized.” But there are several problems with this idea.

First, history suggests that in a pinch, politicians will always bail out politically powerful financial institutions. Second, Fisher calls even temporary government ownership of financial institutions “a clear distortion of our capitalist principles.” Third, arranging a buyer of the failed institution only compounds “the problem, expanding the risk posed by the even larger surviving behemoth organizations.”

And as the Bank of England’s Andrew Haldane puts it:

Policymakers face a trade-off between placing losses on a narrow set of tax-payers today (bail-in) or spreading that risk across a wider set of tax-payers today and tomorrow (bail-out). … For example, in the US the Dodd-Frank Act on paper rules in future bail-in and rules out future bail-out. Yet market expectations of state support for US banks are higher today than before the crisis struck and are unchanged since Dodd-Frank became law.

But I find Fisher’s two-part proposal to be a bit on the whimsical side, given Washington’s bias toward bailouts. Signing a disclaimer isn’t really likely to change banker expectations or government actions. Of course, Fisher buries the lede, the bit about “government-sanctioned reorganization and restructuring” of the Too Big To Fail bank holdings companies. I’ve sketched what that might look like, but Fisher doesn’t, which isn’t surprising given the Fed’s hesitation on giving Congress specific policy advice. But his comments still add momentum to the movement.

  1. Duane Oyen

    Romney’s biggest failing was not putting forth a simple proposal to break up the big banks.  In fact, the best proposal is also the simplest- it has two parts.

    1) Give financial institutions 5 years to reduce their size to below a certain ceiling, including all assets and capitalization; how they elect to do so- whether by shrinking, or divesting, or splitting is their choice.  If they are not done on d-day, a bankruptcy judge takes care of it for them.

    2) Every officer of such an institution places a portion of base and incentive earnings in escrow for 5 years, subject to recall if the basis of the compensation (stock value, profit shares, etc.) falls below a certain average by the end of the period, and each such officer is also automatically terminated- no exceptions- when that institution accepts any bailout money from any government.

    All transparently reported.  You want the goodies, you accept the sunshine.

  2. Peter Robinson
    C

    I have to admit, Jim, that I was dubious at first about your proposals to bust up the big banks–not, Lord knows, that I feel any sympathy for Wall Street.  I just recoil from the notion that the feds ought to be able to bust up any part of the economy.

    But you’re persuading me–persuading me, at least, to take the arguments seriously.

    The state of my own thinking isn’t exactly newsworthy, of course, but this is my oblique way of paying you compliment.   

  3. Duane Oyen
    Peter Robinson: I have to admit, Jim, that I was dubious at first about your proposals to bust up the big banks–not, Lord knows, that I feel any sympathy for Wall Street.  I just recoil from the notion that the feds ought to be able to bust upany part of the economy.

    But you’re persuading me–persuading me, at least, to take the arguments seriously.

    The state of my own thinking isn’t exactly newsworthy, of course, but this is my oblique way of paying you compliment.    · 18 minutes ago

    Peter, have you ever seen this National Review piece by Arnold Kling?  Or this one from 7 months ago?

    Wall Street banks are not run by free market enthusiasts, as Russ Roberts points out at least monthly.

  4. Roberto
    Duane Oyen

    Peter Robinson: I have to admit, Jim, that I was dubious at first about your proposals to bust up the big banks–not, Lord knows, that I feel any sympathy for Wall Street.  I just recoil from the notion that the feds ought to be able to bust upany part of the economy.

    But you’re persuading me–persuading me, at least, to take the arguments seriously.

    The state of my own thinking isn’t exactly newsworthy, of course, but this is my oblique way of paying you compliment.    · 18 minutes ago

    Peter, have you ever seen this National Review piece by Arnold Kling?  Or this one from 7 months ago?

    Wall Street banks are not run by free market enthusiasts, as Russ Roberts points out at least monthly. · 16 minutes ago

    When I agree 100% with you Mr. Oyen everyone should begin to worry.

  5. curtmilr

    Texan Richard Fisher appears to be one of the few remaining honest Democrats (he was a Dem Senate candidate). I generally agree with his economic forecasts and commentaries.

    But I’ll NEVER be able to wholly trust him, because he’s: 1. a banker & 2. a Democrat. Neither breed are worthy of trust ever!

  6. Duane Oyen
    Roberto

    Duane Oyen

    Peter Robinson: I have to admit, Jim, that I was dubious at first about your proposals to bust up the big banks–not, Lord knows, that I feel any sympathy for Wall Street.  I just recoil from the notion that the feds ought to be able to bust upany part of the economy.

    But you’re persuading me–persuading me, at least, to take the arguments seriously.

    The state of my own thinking isn’t exactly newsworthy, of course, but this is my oblique way of paying you compliment.    · 18 minutes ago

    Peter, have you ever seen this National Review piece by Arnold Kling?  Or this one from 7 months ago?

    Wall Street banks are not run by free market enthusiasts, as Russ Roberts points out at least monthly. · 16 minutes ago

    When I agree 100% with you Mr. Oyen everyone should begin to worry. · 15 hours ago

    The key is not to put anyone in a category box.  My views are determined issue by issue.

  7. Duane Oyen

    Simon Johnson offers us some very good advice.  He also had an excellent session with Russ Roberts addressing the financial crisis and regulatory capture by the banks.

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