KC Fed President Tom Hoenig made some blistering remarks this afternoon in Washington. I’ve included some snippets, but the full speech is a must read.
The state of the banking system is worse than ever and the new reform bill did little to change anything:
And some of us are certain that in spite of all that’s been done and debated, the soundness of the largest financial institutions and the systemic risks they continue to pose is no better. In my view, it is even worse than before the crisis. As well-intentioned as the Dodd-Frank Act may be, it will not improve outcomes.
Hoenig says it is time to break up the biggest banks and end too big to fail:
Today, I am convinced that the existence of too big to fail financial institutions poses the greatest risk to the U.S. economy. The incentives for risk-taking have not changed post-crisis and the regulatory factors that helped create the crisis remain in place. We must make the largest institutions more manageable, more competitive, and more accountable. We must break up the largest banks, and could do so by expanding the Volcker Rule and significantly narrowing the scope of institutions that are now more powerful and more of a threat to our capitalistic system than prior to the crisis.
Separate risk taking from the safety net. If too big to fail organizations cannot be effectively supervised, capitalized, or resolved – which is exactly where I contend things stand right now – what option remains?
For me, the answer is firm: they must be broken up. We must not allow organizations operating under the safety net to pursue high-risk activities and we cannot let large organizations put our financial system at risk. Protected institutions must be limited in their risk activities because there is no end to their appetite for risk and no perceived end to the public purse that protects them. As we have seen in this crisis, size and expanded activities have not led to better and more diversified firms as many once argued, but instead have created very large firms with very similar risk profiles that closely mirror the overall financial system and economy.
Capitalism without losers does not work and protecting the bankers during every crisis is the wrong response:
As a result, we have become trapped in a repeating game in which participants continue to seek ever higher and more risky returns while “banking” on the State to fund any losses in a crisis. Large organizations, moreover, are the key players in this process as States become more immersed in the perception during a crisis that they must protect any bank regarded as systemically important. We must stop this game if we are to create a more stable financial system and not condemn ourselves to an escalating series of crises with rapidly rising costs.
This system by the bankers and for the bankers has undermined capitalism:
It is ironic that in the name of preserving free market capitalism in this country, we have undermined it so deeply.
We need harsher reform:
However, one additional option used after the Great Depression still needs to be introduced: Glass-Steagell type limitations on the activities of those organizations that are otherwise too big to fail and that so dramatically affect our national and global economies.
This has been a crisis wasted:
Having said that, real opportunities were missed to deal with size issues during the crisis. In the heat of the moment, rather than break firms into smaller more manageable firms, even the weakest U.S. organizations were allowed to acquire major entities that failed or needed assistance during the crisis. This compounded the too big to fail problem in an already concentrated financial industry. Instead of taking important steps to restructure these firms or resolving them as failures, regulators were required to turn their attention to such side issues as executive bonuses and how troubled institutions could be forced to lend more.
To me the evidence is overwhelming, we should vigorously pursue the restructuring of these firms in a manner that mitigates risk and that would influence the size and complexity of these firms. That is, we must expand the Volcker Rule and carve out business lines that are not essential to the basic business of commercial banking or consistent with public safety nets and then require that these lines be spun off into separate firms.
Wow. Bravo Mr. Hoenig! This sounds like something I could have written. It’s nice to see some influential officials finally starting to really “get it”.
Read the full speech here.
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.