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Kansas City Fed president on financial reform

By Mike Konczal

I would highly recommend checking out this interview between Shahien Nasiripour and Federal Reserve Bank of Kansas City President Thomas M. Hoenig, where Hoenig called for a
fundamental change in Wall Street. In the interview, Hoenig:

  • Lambasted the tilted playing field that benefits Wall Street banks over Main Street banks;
  • Called the idea that the U.S. needs megabanks to compete globally a "fantasy";
  • Said Congress should mandate simple, easily understood and enforceable rules -- rather than guidelines -- so regulators can restrain financial firms and rein in the financial system;
  • Prodded the Senate to get tougher on permanently ending Too Big To Fail by enacting laws that would take away much of the discretion currently held by policymakers (who bailed out financial firms when confronted with these decisions in late 2008);
  • And criticized the Federal Reserve's ongoing policy to keep the main interest rate near zero because it "guarantee[s] a spread to Wall Street", enabling unearned profits and "encourag[ing] speculation."

The full audio is posted, and there are some really interesting parts. He calls for breaking up the largest banks and a restore to Glass-Steagall style separation of banking functions. He describes the idea that the United States needs megabanks as "a fantasy -- I don't know how else to describe it."

Hoenig worries that the Dodd bill, as currently constructed, will increase the concentration of the biggest banks, already at a record high, by having the Federal Reserve become their regulator. He describes the Dodd bill as "a good start" but says that he's worried the resolution authority powers aren't strong enough to use on a megabank firm.

On whether or not to put firm rules into the bill, Hoenig is quite specific that they are needed:

"I think that would do a lot to become counter-cyclical. In other words, when the boom time comes, people and banks tend to say: 'Let's lend more against our capital base, and things are good, we always get paid back.' And it becomes pro-cyclical. [But] when you have a clear rule that says if you want to lend more once you're at this maximum, you have to raise proportionally more capital, then it comes counter-cyclical and much healthier for the economy.

"So I would start with 15. Let the debate go on -- if that's not the right number -- but that's where I would start."

Told that he may upset Wall Street with such a strict ceiling, Hoenig replied: "That's a good sign it must be a pretty good number."

One argument of people like Treasury Secretary Geithner (see this post from yesterday for more details) who are aggressively pressuring Congress to not put strong rules into the bill is that adjusting the rule allows regulators to go "counter-cyclical." They can avoid the temptation to become corrupted or follow the lobbyists' wishes, and be harder in boom times and easier in hard times, which would arguably be more efficient. What Hoenig points out is that a firm rule itself acts de facto in a counter-cyclical behavior -- if you want to be more aggressive in good times, you'll need to raise more capital. Here's more:

Wall Street needs clear rules. "Guidelines are not as effective because they are guidelines. They are much more difficult to enforce," Hoenig said.

"The problem with guidelines and having it vary over time is that it is an opportunity to engage in debate, rather than, 'Here is the rule, let's have it, you must comply with it.' It becomes much stronger and much more counter-cyclical," he said.

"You can't ask an examiner to enforce something that is a guideline because they don't have the ability to do that. They don't have the authority to do that. All they can do is recommend and criticize, but when you give them a rule to enforce, then they will."

Instead, "we need to give them clear sets of rules that can be understood and enforced," he added.

Hoenig and Shahien also discuss the Canadian business model, where there are few gigantic heavily regulated banking firms. " 'Under no circumstances should [the U.S.] emulate Canada,' [Hoenig] said. I don't think it is as competitive, I don't think it allows for the kind of innovation we need, and I don't think it serves the local markets as well as community banks serve the local markets across this country."

Often our discussion of policy is dominated by the short term, by arguments about what is feasible -- Hoenig here gives an idea of what an end goal should look like for our financial sector, and we can then discuss whether the Dodd bill gets us closer or further away from that point. This interview is highly recommended.

-- Mike Konczal is a fellow with the Roosevelt Institute and the author of the Rortybomb blog.

By Washington Post editor  |  April 2, 2010; 9:55 AM ET
Categories:  Financial Regulation  
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