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There is no simple solution to "too big to fail," a complicated problem born of a series of policy missteps that will take years to unwind. The sooner everyone accepts that reality, the sooner we can tackle the necessary items to make sound public policy.
April 3 -
The consensus in Washington is that "more needs to be done" to end "too big to fail," but the bulk of the reforms Congress and the Basel Committee adopted in the wake of the 2008 crisis have yet to be adopted. So no one truly knows if we've done "enough" yet.
May 1 -
During a lengthy interview, Jim Rohr, until recently the chief executive of PNC Financial Group, talked about cybersecurity, "too big to fail" and his bank's culture.
April 25
ST. LOUIS Jim Bullard, the president of the Federal Reserve Bank of St. Louis, is better known for his monetary policy positions, but he is joining the chorus of policymakers arguing that the biggest banks are too big.
In an interview at his office here, Bullard says the "too big to fail" debate is too focused on raising capital standards.
"The crisis was about runnable funds. Capital doesn't really help that," he says. "We have to do more to think about how we are going to prevent that runnable activity."
Large financial firms use short-term funds to take huge risks and then stick the taxpayer with the bill when losses pile up, Bullard says.
"The notion is: I am going to borrow a lot overnight right now and I'm going to go to Las Vegas to put it on black. If I win, I make a lot of money. If I lose, I say, Sorry, the taxpayers are going to have to pay for this,' " he says.
Bullard is proposing a relatively easy-to-understand fix impose a tax on short-term funding.
"What I like are simple rules. A tax is very simple, very clear."
Current policy promotes debt financing by allowing the interest paid on it to be deducted. "Why do we have a tax code
Overnight and short-term borrowings are "all runnable. That's what we found out in the financial crisis," Bullard says.
"So a very simple [fix] would be to tax that activity so that they don't do that," he says. " You could change the tax code to get more reliance on equity finance and less reliance on debt."
Bullard compares the tech bubble of the late 1990s to the recent financial crisis and concludes it did much less damage, because it was financed with equity.
"Firms were taking ridiculous risk, but there was a certain virtue to it," Bullard says. "These were adults. They put their money in and they lost their money. People went home. No one went to the government. And we got a lot of innovation from it."
Bullard is convinced that the world's supervisors are wandering down an unproductive path, and that if they don't change course, banking will be dominated by giants so tied up in red tape they will be unable to innovate.
"We're going to have our big financial firms, but they are going to be heavily regulated," he predicts. "We're going to second-guess every risk decision. We're going to stifle financial innovation in the name of financial stability in these institutions."
Bullard sees the same thing happening in Europe, China and Japan just with a lot less angst. At least here in the U.S., he says, critics are questioning whether the Dodd-Frank Act can accomplish its goal of ending "too big to fail." (Put Bullard firmly in the camp of doubters.)
" Too big to fail' isn't an issue in Europe, especially on the Continent. I'll go over there and I'll be railing about too big to fail' and everyone is looking out the window," Bullard says. "Why is this? It's because they are national champions. The European tradition is they want their big financial firms, and yes, they are going to protect their big financial firms.
"China is going to be hugely protective of their gigantic financial institutions. They wouldn't even dream of keeping them separate from the government. Japan, too."
Bullard says that if the U.S. wants a global competitive advantage it should pursue policies that result in smaller institutions that need less intrusive oversight. Freed from red tape, these firms could capitalize on technological change and outmaneuver giant rivals in other countries.
If the megabanks were small enough to resolve, he says, "you could give [them] more freedom, allow them to be more innovative and let them make mistakes."
"You might win the global battle in financial services in coming decades with that kind of a model," Bullard says. "I think the U.S. could be much better off possibly with that kind of a general strategy as opposed to the big, lumbering, heavily regulated institutions where you are always arguing about every decision that is being made."
So how would Bullard slay the giants?
He's short on specifics, but here's his general approach: create eight to 10 metrics that would reduce size and complexity and then let banks that agree to operate within those ranges do what they like.
"I am just not ready to put something concrete on the table," he says. "I just want to get the idea out there that when people talk about size they usually have one thing in mind assets. I would say put multiple metrics around the kinds of things you don't want to see.
"Stay inside these limits and you can basically do what you want," Bullard adds. "You have many limits, but you'd let firms innovate within these parameters."
Asked for an example of the sort of metric he envisions, Bullard turned to one that's already on the books the cap on controlling more than 10% of the national deposit market.
"A simple example that's in effect today is the cap on deposits," he says. "We are allowing that to be violated, but that's a simple one you could reinforce or even lower it."
Another possibility, he says, might be a cap on the amount of leverage a financial company could take on.
"I am not prepared to say what exactly this would be," Bullard says. "I don't want to put a lot of specifics on the table and have that shot down and let the debate wither."
Bullard praised the stalwarts of the "too big to fail" debate: Simon Johnson, Tom Hoenig and Richard Fisher.
"I'm sympathetic with where they want to go," he says. "I'm outlining a little bit different way to do that."
For instance, Bullard does not believe it's realistic to separate commercial from investment banking, as FDIC Vice Chairman Hoenig has been advocating.
"I think the line has been crossed on that and I don't think there is any going back on splitting up those activities," Bullard says. "Glass-Steagall broke down because it was untenable."
But he agrees that the largest banks enjoy an unfair subsidy, are unwieldy to manage and aren't necessary for economic growth. In short, Bullard doesn't believe the U.S. needs giant banks.
"I don't really think so," he says. "I think you could have smaller, not tiny, but smaller institutions that were small enough that you could let them fail and let them be innovative enough to sort of win the global battle."
Bullard dismisses the argument that global customers need a hulking financial institution.
"This is crazy. Absolutely crazy," he says. "Microsoft has complete access to capital markets on its own. In fact, they won't use a bank unless there is some special circumstance."
Bullard would not say how small is small enough, and he straddled a question about whether he is comfortable with the $500 billion threshold laid out in the Brown-Vitter legislation.
"We can close down a bank of $50 billion. We can close down a bank of $100 billion. $500 billion? I'm not sure."
But then Bullard adds, "I've always been suspicious of suspiciously round numbers. I think you'd like to think seriously about where that cutoff is and have a good reason why you are going to choose a cutoff."
Bullard says the largest banks are too big, mainly too big to manage or supervise. "They are wildly complex," he says. "I am doubtful that those inside the firm really have their heads around the whole company. And then to come in as an outsider, as a regulator, and try to get your head around it, it's very difficult."
