Journalism in the Public Interest

From Big State a Call for Small Banks

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An annual report from a regional Federal Reserve bank is typically a collection of banalities and clichés with some pictures of local worthies who serve on the board.

And so it is with this year's annual report from the Federal Reserve Bank of Dallas, whose pages are graced by the smiling, stolid portraits of board members who run local companies like Whataburger Restaurants.

But the text is something else entirely. It's a radical indictment of the nation's financial system. The lead essay, which is endorsed by the president of the Dallas Fed, contends that despite the great crisis of 2008, a cartel of megabanks is still hindering the economic recovery and the institutions remain too big to fail.

The country's biggest banks look much as they did before the 2008 financial crisis -- only bigger. They have "increased oligopoly power" and "remain difficult to control because they have the lawyers and the money to resist the pressures of federal regulation," Harvey Rosenblum, the head of the Dallas Fed's research department, wrote in the essay.

Having seen the biggest banks make risky bets, crush the economy and get rewarded leaves "a residue of distrust for the government, the banking system, the Fed and capitalism itself," Mr. Rosenblum wrote.

It's one thing for the Occupy movement to point out how bailing out the biggest banks -- with little cost to their executives or shareholders and creditors -- has demolished credibility. It's quite another for top officials in the Federal Reserve system to put it in an annual report.

As for Dodd-Frank's "resolution authority" -- the power to dissolve big financial institutions that Barney Frank famously hailed as a death panel for banks -- well, not so much. "For all its bluster, Dodd-Frank leaves TBTF entrenched," Mr. Rosenblum wrote, using the acronym for "too big to fail."

Yes, Dodd Frank has mechanisms in place to prevent taxpayer bailouts of the largest banks, he concedes. Banks are supposed to have "living wills" that explain how they could be seized and wound down while minimizing the use of taxpayer money.

But the Dallas Fed is deeply skeptical that this would work in real life.

"We know under the current structure that the government would be called on once again," the president of the Dallas Fed, Richard W. Fisher, told me. He has been giving a series of speeches about the continuing problem of "too big to fail."

The biggest banks are like Aspen trees (to borrow a famous, but incorrect, metaphor made by Scooter Libby in a different context): their roots are intertwined and they turn color at the same time. "If you believe the next time the problem will center on one institution and one only, I cross my fingers and am reasonably confident" that regulators will be able to liquidate it in an orderly fashion, Mr. Rosenblum told me. But that one institution would have to be largely in one market, with few lines of business and few connections to other institutions.

Obviously, there's almost no giant financial institution that fits that description. It's more likely that the next crisis will be similar to this one, one with "too many to fail," Mr. Rosenblum contends.

Another problem, the report points out, is that the decision now doesn't rest with the Fed or some institution that has some slight hope of being neutral, but with the Treasury secretary and the president. In other words, saving a big bank now will be even more political than before. Sure, some future president could act courageously, but the Federal Reserve bankers in Texas aren't so naïve as to see that as likely.

Crucially, the Dallas Fed argues that these problems are making the system vulnerable to a future crisis and that the financial oligopoly is undermining the economic recovery and the Fed's efforts to revive growth.

"Monetary policy cannot be effective when a major portion of the banking system is undercapitalized," Mr. Rosenblum wrote in the report. "Many of the biggest banks have sputtered, their balance sheets still clogged with toxic assets accumulated in the boom years."

Unfortunately for our banking regulation system, critics in the regional Federal Reserve banks haven't had much influence on regulatory policy.

One reason is that the regional Fed officials seem to be talking their own book, or can be dismissed as doing so. Outside of New York, Richmond, Va., and San Francisco, the regional Feds oversee only the small and midsize banks that compete with the "too big to fail" banks. The small guys suffer when the big banks are unfairly subsidized by the government, so the regional Feds can be brushed off as merely cheerleading for their team.

Mr. Fisher explained to me that, on the contrary, the Dallas Fed should be heeded because it has experience with "too big to fail": During the savings-and-loan crisis of the late 1980s and early '90s, some of the biggest banks to fail were from Texas.

But another major reason that they are disregarded may be that the rebel regional Fed presidents have been skeptical about the Fed's aggressive and successful monetary policy and overly worried about inflation and the vulnerability of the dollar. That may have undermined their solid case on bank regulation.

Mr. Fisher, the Dallas Fed president, has been one of the fiercest inflation hawks. He has dissented against the Fed's efforts to buy longer-term assets, known as quantitative easing, which was an effort to stimulate the economy. (He has been less worried about inflation more recently, arguing that unemployment is the top problem for the economy.)

"Sound money and sound structure go hand in glove," Mr. Fisher said.

Thomas M. Hoenig, the former president of the Kansas City Fed, also articulated strong, compelling views on bank regulation coupled with a hard-money fever that is discredited in most economic circles. (Mr. Hoenig has been nominated to be vice chairman of the Federal Deposit Insurance Corporation, which -- an economist might say -- is his highest and best use.)

The top bank regulators at the Fed, meanwhile, have embraced unorthodox monetary policies, but have also had scant courage and originality in challenging the current structure of the country's financial system.

Not so with the Dallas Fed. Its report champions "the ultimate solution for TBTF -- breaking up the nation's biggest banks into smaller units."

Hear, hear.

The basic theory is sound and—get this—more capitalistic than megabanks conspiring to decide our fates.  Competition is good.

I was just discussing over lunch that, in twenty-five or so years, I’ve watched banks degenerate from service companies that seduced you into a business relationship to today, where your needs are a gross inconvenience and just hand over your money so they can buy more grain futures, thanks.

Remember how the savings were going to get passed on to us when they replaced their tellers with ATMs?  There are fewer tellers as promised, but you’re paying anywhere from zero (which was the original structure) to six dollars (local and remote transaction fees) to access your money.  Because electrons are much more expensive than minimum wage, perhaps.

Something else I remember hearing at the same time was how monopolies were bad for the economy because, without competition, companies would start charging more for less service.  Heck of a coincidence.

So yes, break them up.  Or destroy them and use the failing Post Office infrastructure to host savings and checking accounts like they did back in the day.  I mean, we have to keep them open anyway, because the Constitution says so, and they need an influx of funding and something to do when it’s not Christmas.

Amen.  Breaking up TBTF banks whose sole ‘job’ is to make money for the share holders and the ‘suits’ rather than to provide a service to the community and to the nation verges onto being a no brainer.  Doubt that breaking up TBTF banks will happen though since Congress is in the pocket of these vultures banks.

I agree wholeheartedly with the Dallas Fed and am simply unable to comprehend why Bernanke and Obama are sitting on their laurels regarding the need to do so.  In my opinion we need leaders who have the GUTS to do what needs to be done for the COUNTRY, NOT for the bankers.  Bernanke needs a good swift kick, and if that doesn’t get him to move off dead center then Obama needs to do whatever is required to make this happen.
I no longer do business with big banks.  Every penny of my money is in the hands of a very responsible credit union.  I have decided to NEVER willingly give a big bank one red cent in the future.

Thanks for the story and the link. I read the essay in Dallas Fed Bank Report and am amazed that someone at the Fed actually does “get It” on the risks of TBTF, the inequities in the current system and the present and future risks to the economy.

One clever suggestion was to level the playing field between the Big TBTF Banks and the smaller banks. It’s about 1% cheaper for the Big TBTF Banks to borrow with implicit government backing, yet the TBTF investments are far riskier.

So level the playing field by requiring the TBTF’s to use their government-provided windfall of cheap borrowing power to raise and to hold more capital. Fairer to the little banks. Fairer to the taxpayers to have a bigger cushion between the them and a TBTF failure.

Just my opinion

tbtf sounds like a death sentence to the American taxpayer gues we will have to cease paying income tax till those criminals are jailed for a long time but then again the systems rigged againstthe middle

And so goes the monopoly of our corporate system playing with their monopoly money and the countries future to the great benefit of just a few. This cycle of crisisies decade after decade are designed by the wealthy few to rob each generation. Just my humble observations. Wake up America and lets take back our country and our future from these fucking blood sucking parasites for all of us and future generations.

The bigger is bad smaller is good is a weak argument. All it does is say a smaller bad bank avoids a major disruption. Size can provide standardization and efficiencies. Take for example a case of more numerous offices as being worse, namely HUD, they offer Multifamily loans from 15 hubs with paper applications from the 50 states and territories (yes paper applications, how stone age!) and they are tripping over themselves to get a 1,000 loans a year done with an agonizing average loan approval time of 18 months.  Contrast that with the much maligned Fannie and Freddie (who’s multifamily businesses have been relatively free of scandal btw) who each produce 1,000 apartment financings a year with a 90 day turnaround with just 1/10th the staff and higher quality. Smaller banks are not more honest. How about we just pass regulations that prevent banks from investing in level 2 and level 3 assets (derivatives, distressed assets, illiquid securities etc.) and make them hold a significant portion of the loans they underwrite (20%). They should be lenders not investors or speculators. Quality would surge, volume unfortunately would drop but banks would be “safe” again. Another point, Canada has six banks total—thats’ right only six for the whole country. How many of them suffered from the mortgage credit crisis? None.  Finally the S&L crisis was caused by 100’s of small banks taking risks, so small banks are not immune to bad decisions. It’s simple, limit exactly what a bank can and cannot do (accept deposits and lend within strict mathmatical guidelines - no exotic stuff)and let alternative unrelated financial companies exist to take higher risks but don’t call them banks. For example if a standard mortgage loan would require a 20% down payment in normal times make it so that if property values spike (up 30% or more in a short period of time) the downpayment would have to increase dramatically as well. That would quickly pop any unsustainable bubble. The top 5 banks today are too big to fail but it is only because they are involved in non-traditional banking activities.

I agree with the premise of the article that our economy is as vulnerable now to a crisis as prior to 2008.  This is irresponsible and we can absolutely hold our elected officials accountable for the mismanagement.  I am not alluding to a left/right ideology though, but instead, to a faulty political system.  To improve the resilience of our economy, it is critical that we make the connection with campaign contributions, lobbying and career movements between the banking industry and regulators.  I expand on the idea from this article at

Buried lede department, Jesse ...?

We only hear about the call to actually break up the TBTF banks in the last paragraph of the article?(!)

I like how the quote of Mr. Rosenblum throws Capitalism under the bus…hahaha rofl…“a residue of distrust for the government, the banking system, the Fed and capitalism itself,” Mr. Rosenblum wrote.

There are so many other entities that could of been included in this residue, other than Capitalism.

so tame;)

Jesse Eisinger

About The Trade

In this column, co-published with New York Times' DealBook, I monitor the financial markets to hold companies, executives and government officials accountable for their actions. Tips? Praise? Contact me at .(JavaScript must be enabled to view this email address)