An interview last week with Federal Reserve Bank of Kansas City President Tom Hoenig yielded more than we could fit into
I know you are no fan of keeping interest rates artificially low. You voted no eight consecutive times when you were on the FOMC last year. Would you have voted no again when the central bank decided to keep rates low through mid-2013?
Hoenig: I think it's a fair conclusion to draw that I would have voted no. The reason I voted no before was I always start out by asking some very straightforward questions: Can you tell me a commodity or a product that trades well with a zero price? Would you expect a different or better outcome with part of the yield curve or credit market? Is the market able to send signals? Are you really allocating resources through the market mechanism where people have to judge risk and understand it and take a calculated decision? Those play a role in allocating credit, and when you take that away and say, "Here it is. It's guaranteed," then you are, I think, inviting a misallocation of resources. I see it today in this part of the country where our land values have accelerated beyond what I think cash flows justify. … When you give a guarantee, you invite speculation and in effect you are subsidizing that speculation. I don't find that healthy for the economy.
What do you see as the biggest issues facing the industry?
Hoenig: Debt and leverage. It has consumed the industry and the consumer.
But isn't that picture getting brighter?
Hoenig: Is it? Consumer debt was 80-90% of disposable income 15 to 20 years ago. That got to 125% at the peak and now it's down to 114%. They have a ways to go. And the banking industry, I don't know because I'm not inside their balance sheets, so I can't know for sure. But I have looked at their reported numbers and equity, which is the only capital that I consider real capital, is for most of them 5% of assets. That's a 20-to-1 leverage ratio.
What should it be?
Hoenig: No more than 15 to 1. I'd prefer less than that, but you can't strangle them down to that, I realize. Banks will do best, and can manage their risk best, from a position of strength, not from a position of vulnerability. And how do you balance that going forward? The reason I don't know the answer is I keep reading about these losses and risks, so I don't know how much loss is in [the largest banks] still, and until you know that, you don't know what the right amount of capital is.
Do you think the large banks know how big their losses are?
Hoenig: I can't say. I don't know what their internal evaluations are and whether they are stepping up to those. They say they are, but I go back a long way and have heard it all before.
What do you think is coming in the banking industry?
Hoenig: If we go forward with no change then I see a far more concentrated industry, because Dodd-Frank has raised the cost of being a banker. Of course that will impact community banks more than it will the largest.
Just playing the devil's advocate, what's the downside? A lot of people think we have too many banks.
Hoenig: We do have a lot of banks, and in over 200 years of our history that has been a huge advantage of ours. We are the most innovative nation. … The way I describe it is that you have, in this country, a range of commercial companies from very large to very small and you had a range of financial companies, from very large to very small. And that allocated credit very efficiently. … But over the last 25 to 30 years, you have concentrated up to fewer and fewer institutions. And I have said I don't have anything against large, but I do have something against subsidizing large financial institutions; that gives them a competitive advantage. That's what we ought to be thinking about as we go forward.
Why are you a fan of the simple rules generally, and straightforward capital rules like the leverage ratio in particular?
Hoenig:I know that risk varies from institution to institution, but you give me a spread sheet and you give me the real leverage calculation, from the most leveraged to the least, and I know where to start looking for trouble. I will find it in the most highly leveraged. Give me rules that are simple and understandable and then they are enforceable. You can't just say, "Use good judgment and good risk analysis." … It's like a speed limit of 25 and police officer stops you going 40. There's no argument. But what if you said, "Posted: Use good judgment"? What would the police officer do until the crash occurred?
Then why don't we streamline both regulation and supervision for the smallest banks? Instituting some sort of tiered regulation?
Hoenig: Why don't we streamline it for everyone? Make it simple, understandable, enforceable. If you have bad loans, charge them off. Isn't that what we do with the little guys? Why don't we do that with the big guys? What's wrong with that? Do we examine them how thoroughly? Is it too expensive to examine them? If it is, there is another reason to break them up.
Do you think policymakers should say something when a strong bank is getting whipsawed by market rumors or repeated bad news?
Hoenig: If you know [the bank is strong], that's fine, but do you know it is? The question is what is your condition? When you can confirm to the world that you have strong capital, a reserve that makes people comfortable, nonperformers that make people comfortable, then all those rumors will stop. If you can't do that, they won't.
So are you saying if a bank's management isn't believed, the bank must not be strong?
Hoenig: I am not saying that, but something is missing.
OK then, is there a role for regulators when that something is missing?
Hoenig: The role of the regulator is to analyze the condition of the bank and report it. I proposed years ago at a Chicago Fed conference that regulatory findings be required to be disclosed. If we find a significant weakness, then it is the duty of the bank to disclose that and say how it is fixing it.
How about the Capital One-ING deal? Do you think the Fed is right to hold hearings and extend the comment period?
Hoenig: Here are the questions I would ask. No. 1, will the pro forma institution have more capital, real capital, or less? How are they paying for this deal? Is there good will in this deal? At the end will I have a more leveraged institution or a less leveraged institution?
Next, I would ask what's in ING? Does it have investment banking activities? Is it doing trading? Is it doing high-risk activities that would be brought into the safety net?
Is it a stronger institution or a less-strong institution? If, in the end, the deal makes it larger and weaker, then I have a problem with it. You have to answer those questions and make a decision based on that.
