Regional Fed Prez Backs EW: TBTF Destroying US Real Economy

While we obviously have a slightly more wild style — and some differences in substance —

it appears that the President of the Federal Reserve Bank of Kansas City

agrees with the basic analysis expressed in our Feature today on

the lessons of the Fed Document Dump for the American economy.

Thomas M Hoenig argues that more must be done

to address a threat that remains increasingly a part of our economy:

financial institutions that are “too big to fail.”

While we obviously have a slightly more wild style — and some differences in substance —

it appears that the President of the Federal Reserve Bank of Kansas City

agrees with the basic analysis expressed in our Feature today on

the lessons of the Fed Document Dump for the American economy.

Thomas M Hoenig argues that more must be done

to address a threat that remains increasingly a part of our economy:

financial institutions that are “too big to fail.”

During the 1990s, Congress, with encouragement from academics and regulators —

thereby affirming as well our contention that the six-fold US crisis has both ideological and intellectual / academic sides —

repealed the Glass-Steagall Act, the Depression-era law that had barred commercial banks from undertaking the riskier activities of investment banks.

Following this action, the regulatory authority significantly reduced capital requirements for the largest investment banks.

Less than a decade after these changes, the investment firm Bear Stearns failed.

Bear was the smallest of the “big five” American investment banks.

Yet to avoid the damage its failure might cause, billions of dollars in public assistance was provided to support its acquisition by JPMorgan Chase.

Soon other large financial institutions were found to also be at risk.

These firms were required to accept billions of dollars in capital from the Treasury

and were provided hundreds of billions in loans from the Federal Reserve.

In spite of the public assistance required to sustain the industry, little has changed on Wall Street.

Two years later, the largest firms are again operating with bonus and compensation schemes

that reflect success — NOT the reality of recent failures.

Contrast this with the hundreds of smaller banks and businesses that failed

and the millions of people who lost their jobs during the Wall Street-fuelled recession.

There is an old saying: lend a business $1,000 and you own it; lend it $1 million and it owns you.

This latest crisis confirms that the economic influence of the largest financial institutions is so great that

their chief executives cannot manage them — nor can their regulators provide adequate oversight.

Last summer, Congress passed a law to reform our financial system.

It offers the promise that in the future there will be no taxpayer-financed bailouts of investors or creditors.

However, after this round of bailouts, the five largest financial institutions are 20 percent larger than they were before the crisis.

They control $8.6 trillion in financial assets —

the equivalent of nearly 60 percent of gross domestic product.

Like it or not, these firms remain too big to fail.

How is it possible that post-crisis legislation leaves large financial institutions still in control of our country’s economic destiny?

One answer is that they have even greater political influence than they had before the crisis.

During the past decade, the four largest financial firms spent tens of millions of dollars on lobbying.

A member of Congress from the Midwest reluctantly confirmed for me that

any candidate who runs for national office must go to New York City, home of the big banks, to raise money.

What can be done to remedy the situation?

After the Great Depression and the passage of Glass-Steagall,

the largest banks had to spin off certain risky activities,

and this created smaller, safer banks.

Taking similar actions today to reduce the scope and size of banks,

combined with legislatively mandated debt-to-equity requirements,

might restore the integrity of the financial system

and enhance equity of access to credit for consumers and businesses.

Studies show that most operational efficiencies are captured

when financial firms are substantially smaller than the largest ones are today.

These firms reached their present size through the subsidies they received because they were too big to fail.

Therefore, diminishing their size and scope,

thereby reducing or removing this subsidy and the competitive advantage it provides,

could restore competitive balance to our economic system.

To do this will require real political will, above all,

to contest those who control the largest banks,

who will argue such action would undermine financial firms’ ability to compete globally.

I am not persuaded by this argument.

History suggests that financial strength follows economic strength.

A competitive, accountable and successful domestic economic system,

supported by many innovative financial firms,

would restore the United States’ economic strength.

More financial firms — with none too big to fail — would mean

less concentrated financial power, less concentrated risk

and better access and service for American businesses and the public.

Even if they were substantially smaller, the largest firms could continue to meet any global financial demand either directly or through syndication.

Accountability and an end to blatant inequities are the pre-requisites for any hope for the rebuilding of the US economy,

Hoenig argues in this provocative and thoughtful Op-Ed piece in the New York Times.