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http://www.econclubny.com/events.php
The transcript is up on the FDIC website:
http://www.fdic.gov/news/news/speech...spapr2709.html
http://www.econclubny.com/events.php
The transcript is up on the FDIC website:
http://www.fdic.gov/news/news/speech...spapr2709.html
...What's needed is a new way to unwind these big institutions. We need an effective resolution mechanism, not a get-out-of-jail free card. Taxpayers should not be called on to foot the bill to support non-viable institutions because there is no orderly process for resolving them. This is unacceptable, and simply reinforces the notion of "too big to fail" ... a 25-year old idea that ought to be tossed into the dustbin.
When the public interest is at stake, the resolution process should support an orderly unwinding of the institution in a way that protects the broader economy and the taxpayer, not just private financial interests.
To be sure, a new resolution regime is not panacea. We also need better and smarter regulation. Many of the institutions that got into trouble were already heavily regulated. We didn't do enough to constrain leverage, regulate derivatives, and most important, protect the consumer. We forgot that there is a difference between "free markets", and "free for all markets".
But while considerable attention has been focused on regulatory shortcomings, not enough has been focused on the lack of market discipline fostered by "too big to fail". To address this problem, we must have a realistic way to close and resolve non-viable systemic institutions.
Here's how a resolution authority could help.
Many have cited a "good bank" -- "bad bank" model for resolving these institutions. Under this scenario, you'd take over the troubled firm, imposing losses on stockholders and unsecured creditors. Viable portions of the firm would be placed into the "good bank" using a structure similar to the FDIC's bridge bank. The nonviable or troubled portions of the firms would remain behind in a "bad bank," and would be unwound or sold over time.
The cost of the bad bank would be partially paid for by the losses imposed on the stockholders and unsecured creditors. Any additional costs would be borne by assessments on other systemically risky firms. This has the benefit of quickly recognizing the losses in the firm and beginning the process of cleaning up the mess.
The stockholders and managers of some big banks might not like this process. They might prefer a too-big-to-fail subsidy or investment from the government. (And some regulators might fear it because it would give an independent body the ability to close institutions for which they are responsible.)
Short term pain, long term gain
It would be a brave new world which, in the short term, could increase the cost of capital for large institutions. Investors and creditors will come to understand their own responsibility (and the wisdom) of conducting due diligence of the strengths and weaknesses of bank managers and balance sheets. In turn, investors and creditors will charge a premium for the newly recognized risk, that indeed, these institutions could fail.
This is as it should be. Everybody should have the freedom to fail in a market economy. Without that freedom, capitalism doesn't work. In the longer term, a legal mechanism to resolve systemically important firms would result in a more efficient alignment of capital with better managed institutions. Ultimately, this would benefit those better managed institutions and make the financial system and the economy stronger and more resilient.
Funding
So who should pay for an "anybody can fail" doctrine? Certainly not the taxpayer. As a tax-paying citizen, I don't favor encouraging foolish behavior. Nor should those costs be borne by the Deposit Insurance Fund, which should continue to be used only for the costs of protecting depositors when banks fail.
A new resolution authority could include assessments on larger firms to fund a reserve that would be tapped to absorb losses for a failure. I believe it's only fair that the industry that benefits should pay ... just as banks pay for deposit insurance.
The assessments could be based on the differential in the cost of capital between smaller institutions -- which clearly can fail and thus have higher costs -- and their larger competitors. Moreover, we should not base this strictly on size, which might not be perfectly aligned with risk. For example, a large mutual fund that invests in the S&P 500 is not systemic. Risk-based surcharges should be imposed on higher risk behavior. This might include certain derivatives, market making or proprietary trading, and rapid growth. We now have such a risk-based system for the insurance premiums we charge for deposit insurance, and it's working very well.
Where to put the new regime
Who is best-able to get the job done? I don't think we need another government bureaucracy or program. This is cyclical work. We have a lot of agencies already. I'm not sure it makes much sense to create another one that would need to be staffed up and ready to go. But the FDIC is up to the task, and whether alone or in conjunction with other agencies, the FDIC is central to the solution. Given our many years of experience resolving banks and closing them, we're well-suited to run a new resolution program...
When the public interest is at stake, the resolution process should support an orderly unwinding of the institution in a way that protects the broader economy and the taxpayer, not just private financial interests.
To be sure, a new resolution regime is not panacea. We also need better and smarter regulation. Many of the institutions that got into trouble were already heavily regulated. We didn't do enough to constrain leverage, regulate derivatives, and most important, protect the consumer. We forgot that there is a difference between "free markets", and "free for all markets".
But while considerable attention has been focused on regulatory shortcomings, not enough has been focused on the lack of market discipline fostered by "too big to fail". To address this problem, we must have a realistic way to close and resolve non-viable systemic institutions.
Here's how a resolution authority could help.
Many have cited a "good bank" -- "bad bank" model for resolving these institutions. Under this scenario, you'd take over the troubled firm, imposing losses on stockholders and unsecured creditors. Viable portions of the firm would be placed into the "good bank" using a structure similar to the FDIC's bridge bank. The nonviable or troubled portions of the firms would remain behind in a "bad bank," and would be unwound or sold over time.
The cost of the bad bank would be partially paid for by the losses imposed on the stockholders and unsecured creditors. Any additional costs would be borne by assessments on other systemically risky firms. This has the benefit of quickly recognizing the losses in the firm and beginning the process of cleaning up the mess.
The stockholders and managers of some big banks might not like this process. They might prefer a too-big-to-fail subsidy or investment from the government. (And some regulators might fear it because it would give an independent body the ability to close institutions for which they are responsible.)
Short term pain, long term gain
It would be a brave new world which, in the short term, could increase the cost of capital for large institutions. Investors and creditors will come to understand their own responsibility (and the wisdom) of conducting due diligence of the strengths and weaknesses of bank managers and balance sheets. In turn, investors and creditors will charge a premium for the newly recognized risk, that indeed, these institutions could fail.
This is as it should be. Everybody should have the freedom to fail in a market economy. Without that freedom, capitalism doesn't work. In the longer term, a legal mechanism to resolve systemically important firms would result in a more efficient alignment of capital with better managed institutions. Ultimately, this would benefit those better managed institutions and make the financial system and the economy stronger and more resilient.
Funding
So who should pay for an "anybody can fail" doctrine? Certainly not the taxpayer. As a tax-paying citizen, I don't favor encouraging foolish behavior. Nor should those costs be borne by the Deposit Insurance Fund, which should continue to be used only for the costs of protecting depositors when banks fail.
A new resolution authority could include assessments on larger firms to fund a reserve that would be tapped to absorb losses for a failure. I believe it's only fair that the industry that benefits should pay ... just as banks pay for deposit insurance.
The assessments could be based on the differential in the cost of capital between smaller institutions -- which clearly can fail and thus have higher costs -- and their larger competitors. Moreover, we should not base this strictly on size, which might not be perfectly aligned with risk. For example, a large mutual fund that invests in the S&P 500 is not systemic. Risk-based surcharges should be imposed on higher risk behavior. This might include certain derivatives, market making or proprietary trading, and rapid growth. We now have such a risk-based system for the insurance premiums we charge for deposit insurance, and it's working very well.
Where to put the new regime
Who is best-able to get the job done? I don't think we need another government bureaucracy or program. This is cyclical work. We have a lot of agencies already. I'm not sure it makes much sense to create another one that would need to be staffed up and ready to go. But the FDIC is up to the task, and whether alone or in conjunction with other agencies, the FDIC is central to the solution. Given our many years of experience resolving banks and closing them, we're well-suited to run a new resolution program...