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The Fed's foreign bank regulation proposal may make sense, but it appears to signal that global standards are giving way to an every-country-for-itself approach.
January 9 -
With President Obama re-elected and Senate Democrats in the legislative driver's seat, the Dodd-Frank Act is here to stay.
November 14
Talk of narrowing the safety net is gaining traction.
It's another way into the "too big to fail" debate, but rather than focus on breaking up the big banks, this discussion centers squarely on what, exactly, the government should guarantee.
The thinking is simple: if policymakers made it crystal clear that the government only stands behind traditional commercial banks, then the market would discipline the companies and activities outside the safety net.
Without the expectation of a bailout, investors and customers would require higher capital and that in turn would constrain the growth and risk-taking of companies or lines of business that operate outside the safety net. The scope of regulation could shrink because we'd only have to police what we backstop, and moral hazard would finally start to recede.
That all sounds great, but can policymakers take us from here to there? Can they really put the TBTF genie back in the bottle?
"It's going to take some guts, but it's doable," says Tom Hoenig, vice chairman of the Federal Deposit Insurance Corp. and an early and dogged leader of the movement to shrink the safety net.
Critics raised the same issues when the Glass-Steagall Act was passed in 1933, he says, and Congress gave companies 18 months to separate their commercial and investment banking interests. "Today it could be done in 24 to 30 months."
Critics "say this is wishful thinking, but I am telling you: If we don't do this, we will write another check," Hoenig insists, referring to the $700 billion industry rescue program Congress enacted in 2008.
And the backlash that will follow that bailout, Hoenig predicts, will devastate the banking industry — reshaping it into a public utility with price controls, product restrictions and salary limits.
John Dugan, the comptroller of the currency during the crisis, takes the opposite view.
The notion of shrinking the safety net is "misguided, and I think it flies in the face of what happened," Dugan says. "We had a regulatory system that was very much focused only on banks because they had access to the safety net and didn't focus on the nonbanks that were increasingly important systemically. And in the crisis that's where all the problems came from."
Dugan, now a partner at Covington & Burling, says the government didn't have the authority or tools it needed during the crisis to deal with companies beyond the safety net like the insurance giant, American International Group.
"To me, as it was to everyone sitting in government at the time, that was one of the essential problems we had to address," he says. "It is absolutely critical that the government be able to see what is going on inside an AIG so we don't end up pouring $180 billion into a single company.
"We can pretend that if we only kept the safety net focused on depository institutions that somehow the problems will go away. I really think that is fundamentally misguided."
Dugan also notes that "the companies that had more regulation did better." Banks fared better than bank holding companies and bank holding companies did better than nonbank holding companies, he says.
That two supersmart, dedicated people can see this issue so differently says a lot about how hard these public policy questions are.
Let's make one thing clear: under current law, deposit insurance and the discount window — the safety net — are only available to commercial banks.
But in a crisis, policymakers tend to expand the safety net and everyone in the market knows it.
During the aftermath of the 2008 crisis, policymakers raised deposit insurance levels, backstopped bank debt and even guaranteed money market funds.
And over the years, the activities that banks conduct directly have expanded far beyond traditional activities like lending. While there are rules restricting how a bank shares assets and earnings with a parent or an affiliate, they aren't that tough and exemptions are granted, particularly when a company gets into trouble.
"It's not just what's inside a bank," Hoenig says. "When you get all this stuff underneath the same corporate entity, believe me, desperate people do desperate things and the fences come down or are burrowed under."
Dodd-Frank did impose reforms designed to make a difference. Insured banks are banned from proprietary trading and some derivatives businesses, and the largest firms, including ones beyond banking, will have to submit detailed resolution plans that would be used if they got into trouble. The law creates a new regime for taking over and unwinding giant financial firms and imposes strict new limits on what regulators can do to assist a faltering company.
But while the Dodd-Frank fixes are sound in theory, plenty of skeptics figure policymakers will simply change the rules when the next crisis hits.
All this boils down to a fundamental difference: do you believe aggressive oversight and regulation of all large financial firms can ensure a stable financial system, or is it better to restrict the safety net and let the market discipline what is explicitly not guaranteed?
Where you land may depend on how you view the inverse of these questions.
Do you think regulators can effectively oversee a growing and increasingly complex financial sector? Or do you think it's impossible to ever convince markets that the days of repeated bailouts are over?
Tough questions, but no easy answers.
Barb Rehm is American Banker's editor at large. She welcomes feedback to her column at
