Kansas City, Mo.
LAST week, I visited Santa Fe, N.M., and spoke to one of America’s many Main Streets: more than 300 small-business owners, real estate developers, artists, bankers and other citizens. A good number of them, experiencing the fallout of the financial crisis and feeling the stress it put on New Mexico’s banks, were angry and frustrated.
You see, New Mexico’s financial institutions were not too big to fail. They were never invited to meetings and told to accept financing from the Troubled Asset Relief Program. As a result, banks and residents of Santa Fe, like those in towns all over Middle America, have struggled mightily through this recession. It was clear that, like politics, the effects of financial crises are mostly local.
This explains why it undermines the very foundation of our economic system when the government decides that a financial institution is too big or too powerful to fail. The big banks and investment companies hold a significant advantage in the competition for funds (for example, from depositors and bond holders), because creditors know that they will be bailed out when a crisis occurs. This advantage has systematically undermined the competitive position of every smaller bank, and has enabled the largest banking organizations to more than double their share of industry assets since the 1990s. These trends serve neither the national economy nor communities like Santa Fe. And in the end, they are a burden on taxpayers.
Unfortunately, the proposal for regulatory reform now before the Senate does not eliminate the concept of too-big-to-fail, and it deliberately narrows the central bank’s focus to Wall Street alone. This undermines reform in at least two important ways.
First, the decision to close a large financial firm that is failing would depend on the Treasury Department’s petitioning a panel of three United States Bankruptcy Court judges for approval to place the firm in receivership with the Federal Deposit Insurance Corporation. The panel would have 24 hours to make a decision, and if it turned down the petition, the Treasury could re-file and subsequent appeals could be considered. So a decision to put the firm in receivership might not be timely enough under the circumstances. And experience tells us that the urgency of the moment would likely motivate politically sensitive officials to simply pursue a bailout.
Instead, the new law should require that any institution deemed insolvent, based on an established, objective set of criteria, be placed into receivership and resolved in an orderly fashion — just as banks on Main Street are.
Second, the proposed financial reform legislation would significantly narrow the supervisory role of the Federal Reserve, so that it would oversee only the very largest institutions, most of which are headquartered in New York City. Congress established the Federal Reserve System in 1913 with 12 banks in a federated structure, like our political system, so that it would include regional perspectives to counterbalance the influence of Wall Street and Washington. To now narrow the Fed’s supervision to just the largest banks would be to devalue those broader perspectives. The Federal Reserve would no longer be the central bank of the United States, but only the central bank of Wall Street.
The flawed logic of this proposed change is that only the biggest firms are systemically important; that only they require the contingency lending that the Fed provides at its discount window; that only they will be involved in future crises; and that overseeing these firms is sufficient to provide the “macro-prudential supervision” the central bank’s charter requires. By this reasoning, the 6,700 other banks and the communities they serve are of no immediate consequence to the mission of the Federal Reserve.
Who outside of Wall Street can legitimately support such thinking? As a commissioned examiner and head of supervision in the Fed’s Kansas City district in the 1980s, I am a veteran of financial crises involving energy, real estate and agriculture in the Midwest and West. I can say with confidence that a regional financial crisis and its accompanying loss of jobs is just as harmful as the current Wall Street crisis has been for communities like Santa Fe.
Because the Federal Reserve supervises banks and bank holding companies of all sizes, it is able to address regional as well as national banking problems when they erupt. In addition, I and other Fed presidents can take information about regional financial and economic conditions into monetary policy discussions.
Without the Fed seeing the view from every corner of America, without every bank knowing it will be treated the same, the Federal Reserve cannot do its job and direct the same attention to the smallest firms as the largest. It cannot serve Main Street.
Thomas Hoenig is the president of the Federal Reserve Bank of Kansas City.
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