What happened to the global economy and what we can do about it
with 25 comments
By James Kwak
Many of you have probably already seen Shahien Nasiripour’s interview with Thomas Hoenig, president of the Federal Reserve Bank of Kansas City and the most prominent advocate of simply breaking up big banks. (Paul Volcker is more prominent, but his views are more nuanced; the famous Volcker limit on bank size, it turns out, would not affect any existing banks, at least as interpreted by the Treasury Department.) It largely elaborates on Hoenig’s positions that we’ve previously applauded in this blog, so I’ll just jump to the direct quotations:
On megabanks:
“I think they should be broken up. . . . We’ve provided this support and allowed Too Big To Fail and that subsidy, so that they’ve become larger than I think they otherwise would. I think by breaking them up, the market itself would begin to help tell you what the right size was over time.”
On whether the United States needs megabanks to compete globally:
“That is a fantasy — I don’t know how else to describe it. Our strengths will be from having a strong industrial economy. We will have financial institutions that are large enough to give us influence in the markets but not so large that they’re too big to fail. . . .
“The United States became a financial center not because we had large institutions but because we had a strong industrial economy with a good working financial system across the United States — not just highly-concentrated in one market area.”
On the Dodd bill and regulatory discretion:
“There’s still this desire to leave discretion in the hands of the Secretary of the Treasury, and while I understand that desire — because you never know what the circumstance is going to be — the problem is in those circumstances you always take the path of least resistance because of the nature of the crisis.
“You don’t want to be the person responsible for the meltdown, so you take the exception and you move it through.
“But if you had a good firm rule of law, and the markets knew. . . there were no exceptions . . . you would be in the long run much better off.”
There was one thing I didn’t agree with. Hoenig seems to say that if you break up the big banks, the market will determine what size they should be. I think that if you broke up the big banks and left them to their own devices, they would reaggregate into new megabanks — precisely because of the funding advantages that you get from being too big to fail. So I think there needs to be a size limit that is actively policed by the government.
Written by James Kwak
April 9, 2010 at 6:01 pm
Posted in External perspectives
Tagged with Hoenig, TBTF
“there needs to be a size limit that is actively policed by the government.”
I’m pretty much of a newcomer to this entire debate so would someone clue me in on how to do this. Asset caps? Higher core requirements? Limiting the scope of banking operations a la Glass-Steagall? Harsh language? Something else? All of the above?
democritus
April 9, 2010 at 6:40 pm
I’m in favor of reimposing Glass-Steagel. The risks financial institutions are now allowed to take are ridiculous. What’s the big deal about SOMEBODY, Congress, regulators, establishing simple, straightforward rules limiting bank activity? Retroactively. On everybody.
Finance workers love gambling. They are compulsive gamblers. They must be kept from the tables.
raya sunshine
April 10, 2010 at 10:36 pm
I should like to see Hoenig’s other proposals to help ensure that we develop a “strong industrial economy”, beyond breaking up TBTF banks and tightening credit.
StatsGuy
April 9, 2010 at 6:54 pm
I was wondering about that,too. Would building Hoenig’s strong industrial economy necessarily involve some sort of industrial policy and if so how would that work? Maybe a tax credit and/or subsidy policy targeted towards selected high-tech industries(which raises the potential problem of “lemon socialism”). Or a policy aimed at strengthening education and infrastructure across-the-board and letting the private sector do the rest.
democritus
April 9, 2010 at 9:51 pm
Strong industrial base would first mean to make it expensive to produce overseas and sell in the US.
Tax-cuts towards corporations? I’d strongly qualify that by saying, reduce the regulatory and taxation burden for small business–give them a quasi-free pass for the first few years, if you like.
Then, I’d move against the management class by giving shareholders rights over the boards of directors.
Last but not least, if I were to cut taxes anywhere for the big business, that would be for any unit of US-produced output that sells on the international markets.
via fCh
April 10, 2010 at 10:28 am
Strong industrial base would mean asking our banks to renew their role of risk-takers allocating capital to the most productive opportunities instead of having them pursuing the AAAs because that is what the regulators have decided they do by giving them very low capital requirements to finance what is perceived as low risk by some credit rating agencies"¦ though no one is very little clear what low risk really means"¦ low risk to default? "¦ is that all there is to it?… we will have enough of that stability when in our graves.
Per Kurowski
April 10, 2010 at 10:46 am
Agreed. The traditional role of banking has been to allocate scarce capital to smaller (read riskier) businesses to enable them to grow. Banks that did this well, grew in tandem with the companies they helped to succeed. Organically.
In our modern days of megabanks, this George Bailey-style banking model has gone away in favor of smaller banks’ emulating the mega bank models of portfolio management. This enables further consolidation in ‘banking’, but doesn’t fill the vacuum left on the growth investment side.
In too many cases, the default ‘organic’ growth model for small and mid-sized banks today is to emulate the megabanks, thereby making themselves attractive aquisition targets – not drivers of our economy.
How many times have you heard people comment that ‘the banks only lend to those who don’t need the money’ in the last decade? Anecdotal, but meaningful evidence.
VC/PE loans in terms that further suck the oxygen from growth companies.
In a vaccum of productive pro-growth business loans to enable up-n-coming companies, the organic growth in our economy has been replaced by a large and comical game of banking pocket pool.
Traditional banking services are necessary component to a growing economy. So, not surprising that our economy is tanking.
Note: I read ’strong industrial base’ to encompass service industries that facilitate growth – like technology implementation services, business formation services, management services, traditional banking services, etc… and I do not read it as a veil for protectionism or a plea to return to a manufacturing-only economy.
Without a flourishing, well-regulated, traditional George Bailey-style boring banking system – our economy will remain in the crapper for a very long time.
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