In a speech at the National Press Club hosted by the Committee for the Republic on January 16, Richard Fisher, president of the Federal Reserve Bank of Dallas, presented a plan to require the twelve largest banks in the United States to restructure their activities so that only their banking activities would fall under the protection of the federal safety net, while all other activities would have to be placed under the holding company or divested.
This article will set forth the arguments Fisher made to justify his proposal, the elements of the proposal itself, and the strategy he laid out for getting it approved by Congress. Finally, the article will discuss several weaknesses in the proposal that the writer suspects will prevent it from ever being implemented in a form that can achieve the objectives of President Fisher.
Fisher began by attacking the Dodd-Frank Act as bound to enrich lawyers without resolving the issue of the treatment of the largest banks as too big to fail. He defined the doctrine as the implicit but widely accepted notion that the failure of these banks could harm the economy. He observed that the safety net intended for the banks has been extended to cover their nonbanking activities. The result, he complained is to impede competition and exacerbate the advantages the largest banks enjoy. He concluded that the industry and its regulation are too complex, and steps must be taken to simplify them, then allow Schumpeter’s theory of “creative destruction” to do its work. Thus, the Dallas Fed’s proposal would relieve small banks of unfair competitive pressure by leveling the playing field, leaving only banking activities protected by the safety net.
According to statistics assembled by the Dallas Fed, the twelve largest banks account for almost 70% of the banking assets in the United States. He contrasted the conditions under which three categories of banks compete. Community banks have relatively few shareholders and know that if they are not soundly managed, they can be taken over in a weekend. Regional banks have more diverse shareholders and activities but are not too big to fail. By contrast, the twelve largest banks are widely held and are not subject to meaningful market discipline by shareholders, uninsured depositors, or unsecured creditors. The Bank for International Settlements (BIS) has found that the largest banks enjoy a funding advantage of a full 100bp. Lord Haldane has estimated that the value of this subsidy is $300b, nearly triple the value of all of the industry’s earnings, $108b. Moreover, the market capitalization of two of the largest banks declined by 95% during the 2008 episode of the financial crisis. Fisher cited the case of Lehman Brothers as a much smaller institution than the twelve largest banks but one that was still too large and complex for the authorities to resolve. He remarked that the provision of debtor-in-possession (DIP) financing would have amounted to quasi-government ownership.
Fisher proclaimed that the Dallas Fed plan calls for reshaping financial institutions so that market discipline and regulatory supervision can restrain risk taking. The safety net would be rolled back and never apply to shadow banking activities. A new covenant would be signed by those entering into transactions, acknowledging the banks’ unprotected status. The plan promotes competition and replaces incentives to take risk. Admittedly, some government intervention might be necessary, but market forces should be relied upon as much as possible. He stated that, “Bailout and the end of the world economy are not the only choices.” Fisher opined that the recent run-up in bank stocks is due to an expectation that Dodd-Frank will address the too-big-to-fail problem.
Asked by the host, Boyden Gray what his strategy will be for getting the plan through Congress, Fisher responded that it will be difficult, but he believes the support of the community banking, which he said represents “the most powerful lobbying force, whose members know every member of the legislature, who they sleep with, drink with, and their habits.” He recognized that according to a National Journal article, incoming Treasury Secretary Jack Lew is expected to favor the big banks, but he said that leading bankers Frost and Stephens, as well as former Citigroup CEO Sandy Weill have expressed support for breaking up the largest banks.
This writer’s view is that the Fisher proposal will be useful in promoting debate, but its backers are naïve if they think that a plan from Dallas is going to recast the regulation of banks, that signing a document is going to stand in the way of a rush to bail out well connected megabanks, and that bank supervisors are suddenly going to toughen their treatment of banks for whom they have probably worked in the past and hope to work for in the future.
Moreover, Fisher does not seem to realize that the community banks he is looking to as bulwarks against megabank domination looks to those very same megabanks to do their banking, a fact Jamie Dimon loves to point out when he is asked about the effects of megabank concentration. Finally, it is a bit troubling that one of Fisher’s complaints is that the ability of the megabanks to use the implicit federal guarantee as a funding advantage detracts from the ability of policy makers to use monetary stimulus to boost the economy. This indicates that despite his generally conservative message, Fisher is willing to support intervention in the name of short-term stimulus through QE-n at the risk of touching off another bout of inflation or stagflation. He probably thinks the Fed will be able to withdraw the stimulus at just the right time to avoid this consequence, but the history of Fed policy suggests that by the time there is overt evidence to indicate it is time to raise rates, it will probably be too late.