A Q&A with Fed's Fisher on Volcker Rule, JPM Loss and Bull Fences

WASHINGTON — Richard Fisher, the president of the Federal Reserve Bank of Dallas, has become a leading stalwart for breaking up the largest financial institutions, arguing that Dodd-Frank did not end "too big to fail."

Fisher sat down with American Banker to talk about when a bank is too big, if more capital will ever be enough, and why it's time for regulators to go back to simplicity when it comes to crafting a rule to ban proprietary trading.

The following is an edited version of the interview.

There are a lot prominent individuals that have joined the ranks in backing the "break up the banks" argument you've made. Why do you think the argument against 'too big to fail' and breaking up the largest banks seems to be growing louder and louder?
FISHER: You have a couple of pugnacious people like me and I'm just one. I'm not alone. You just pointed that out. Who have generated the argument; who have kept it alive. This may be conceit, but I think there is a virtue to the argument and sometimes virtue comes to the fore. I'm glad the argument has been joined, I think it will continue. My expectation is the volume will be turned up on this. I don't expect anything to happen short term. In a way, the complexity of all these regulations and the segmentation of and dissection of the Volcker Rule and so on, I think are only going to heighten the intensity of interest in the simplification in having clarity and too big to fail will stay at the forefront.

I know that you haven't specifically commented on JPMorgan Chase & Co. and the most recent episode with the $2 billion trading loss. But does this event make a stronger case for breaking up the biggest banks?
There's a first rate banker. I personally think very highly of Mr. [Jaime] Dimon. He runs one of the best run mega-institutions in the world. But I think it's an example of what can go wrong. Here's one of the very best people, extraordinarily talented, capable, very proud of the risk management model, something slipped through the cracks. Question: can you really manage something that large? So are there limits to size and scope? Is there justice in having the implicit and explicit subsidies that a large institution like that has to take that kind of risk with capital? It's still not clear to me, and it's not clear to anybody where that would have fallen in the Volcker Rule, were they hedging their own position, or hedging somebody else's. We'll learn that over time.

You said earlier you were relying on the private sector to come up with a plan to break up the banks. But you talk about it a lot. You think about it a lot. Do you have a sense of what the cap should be on how big is too big? How one would go about breaking up these institutions?
Break-up sounds like something destructive, and again, we're not trying to be bulls that carry around our own China shop with us. That's not the purpose of the exercise. Here's my simple analogy because I'm a Texan and because our family has a ranch. We have longhorns and we have a breeding bull and we run Heinz 57 variety cattle on our property. If we didn't have a fence line they'd run all over the place. There has to be some kind of definition that allows our breeding bull to do what he does for a living with our cows, but he can't just wander off and do whatever it is he wants to do with somebody else's cows. I think it's important to have a definition. As to what the right acreage and the fence line should be, I'm interested in seeing what comes out of the brightest minds, which are usually in the private sector and also a great many economists. So, why don't we see what comes out? Nothing is going to happen between now and the election. So I'm not going to make specific proposals. I could put on my old hat, but I think the risk being run there is you might state a bias or stifle creative minds that are likely to come up with creative solutions.

That's a great analogy. There are some regulators, Fed Chairman Ben Bernanke being one of them, who would suggest that capital would be a good form of a fence, if you will.
It is one of the proposals, and this is where [Fed. Gov. Daniel] Tarullo is working very hard, particularly with the biggest of the big and there's an international dimension to that as you know as well. This goes back to the Banking Act of 1864. We keep trying to do capital standards. So far it hasn't worked too well. The basic underlying principle is: if you are a depository taking institution that takes money that is guaranteed by the taxpayer, you should be limited in the risk you can take with that cheaper cost of funds. As Tom Frost said … you're first duty is to guarantee the safety of those deposits and give it back to the depositors.

Chairman Bernanke said at the April 25 press conference that it's regulators job to take away the incentives that are thought of when you think of a 'too big to fail institution' and a lot of that comes in the form of tougher supervision, i.e. higher capital, higher liquidity, and orderly liquidation authority. Do you disagree? How much capital is enough that we wouldn't have to deal with this issue of breaking up the banks?
It's one approach. Our approach is easier to implement. I think it's going to create enormous complexity. It adds to the nature and size of bureaucracy. I don't disagree with the Chairman. I watched him answer your question, he didn't turn that off. But what he did was he answered with what we are doing. And gosh, I hope it works. But if you listen, setting aside Mr. Bernanke here, the answers you are getting are very complicated answers and they require very complicated mechanisms. Again, I come back to the fact the more complicated they are, the more the bigger institutions are going to figure out a way to navigate their way around these things. So hopefully out of all of this discussion will come a constructive dialogue. When push comes to shove and a large institution is in trouble, it's highly likely that despite having said, 'I told you so, I told you so, I told you so, we have these rules, we have these rules, we have these rules, that the argument is going to be made, 'We can't let this happen.' I'm not the least bit critical of the sincerity of the chairman's answer. That is what we are working on systematically. I worry about its efficacy without doubting the sincerity of the individuals involved or the hard work that their doing.

It's fallen to the shoulders of the FDIC really to prove itself that should an institution be on the brink of failure whether or not they would actually pull the trigger. There seems to be some skepticism out in the market that the FDIC in fact would. Do you think they've been effective in communicating to the market their intent? Do you think there is more work for them to do to convince everyone they will actually allow a bank to fail?
When you communicate there's a person who communicates and there's a person who listens. I don't know a single market operator that's not skeptical. So, again, this isn't to be critical of the people that are communicating, 'Listen, I mean business.' But there are a lot of people in fact, everyone that I know, that used to be like me that are saying, 'Give me a break, it's not going to work. I'll figure out a way around this thing.' A lot of these traders by the way within these institutions they'd kind of like to be liberated. They don't want to be tied up by extraordinarily complex rules, what can I do, what can I not do. I'm pretty confident there is a lot of support for this, a lot of support, even within these institutions.

Support for breaking up the banks?
Yeah. Let's put it this way right-sizing, down-sizing. Breaking-up sounds violent.

There are some that make that argument that the FDIC will feel the need to take action to resolve an institution for the sake of credibility, but will try not to get into that position as much as possible. Do you agree?
The banking system is very important. It is the intermediary device where you bridge short-term deposits with long- term risks. It's a major utility, which provides a vital function for capitalism and the workings of American capitalism. But I think it's gotten carried away with itself. I'm not trying to stuff us back into the old bottle. There ought to be huge claw backs on compensation. If these institutions got themselves into trouble, there should be severe penalties. Where I came from, which is Brown Brothers, you lost your entire net worth if the bank failed. You have corporate structures to prevent that from happening. With banks I'd go back to the old way of doing things. You would think very, very clearly about the risk you were undertaking, if your own net worth was placed at risk.

I know you've been a critic of Dodd-Frank. What would you like to have seen fixed that would have given you that assurance that maybe we have an answer to our problem here?
I would have liked to have seen an effective treatment of 'too big to fail' by seeing institutions could not be too big to fail. You think about a couple thousands pages; and section after section after section, to me, that just gives people ways to maneuver around and exploit.

As a result of the episode with JPMorgan, there have been calls to strengthen the 'Volcker Rule.' How do you think regulators should proceed? Should they move faster, or is it time to pump the breaks and figure out what happened before actually trying to promulgate the rule?
Any regulator wants to be thoughtful in promulgating a rule. Unfortunately, in Washington the more thoughtful you are, that means the more complicated things become. I go back to Paul [Volcker] on that one. He wanted something very simple and then it was argued that it can't be that simple. He's a wise man. He's seen every side of everything. He's done it for a long time. And he will tell you, as he's told the public; this thing is becoming so complex he can't even understand it. The basic underlying principle is not taking risk with deposit-based money. Keep it simple.

But obviously, the language Congress used has not made things easier. How do regulators even begin to solve making the distinction between market-making and proprietary trading?
It's very, very difficult. The prop desks know what proprietary trading is. In a way the cat was let out of the bag again with Citi and Travelers and everything's become infinitely more complicated.

Do you think regulators will abandon the rule?
No. I do think that a big fat exhibit has been put up there. This did not imperil the safety of that individual bank, but it did highlight the fact that risk was taken. More facts have to be found about this, so I think you have to be careful prejudging this thing. I think the fact that you had an individual who is extremely highly heralded as being excellent at what he does as a leader just brought this to the fore. I haven't commented on it specifically. My argument is the same argument whether that would have happened or not.

Do you think regulators should be in the role of micro-managing when it comes to bank supervision?
No, that's not the way American capitalism works. Create a rule, let it stand. We wrestle ourselves off the map through micro-management. I don't tell that bull how to breed. He knows his business, but we do put a fence line.