Dallas Fed: Break Up the TBTF

March 30th, 2012
in econ_news

Econintersect:  The Federal Reserve Bank of Dallas and its president Richard Fisher (pictured) are generally known as conservative, hard money fisher-Richard-Dallas-Fedproponents.  Often conservative economic thinkers are strong laissez-faire proponents.  That is why the 2011 annual report of the Dallas Fed, released this month, has been such a surprise.  A focal point of the report is very interventionist, calling for direct government action to force the break-up of the nation’s largest banks, the so-called TBTF (too big to fail) institutions.

The focus of the report is an essay by Harvey Rosenblum, Executive Vice President and Director of Research.  Key points made by Rosenblum follow the “Read more” break.

Follow up:

The consolidation of banking in recent decades is shown in the following graph from the Dallas Fed annual report:



Rosenblum makes compelling arguments that this consolidation must be reversed.  Key points by Rosenblum include:

  • [Dodd-Frank] may not prevent the biggest financial institutions from taking excessive risk or growing ever bigger.
  • TBTF institutions were at the center of the financial crisis and the sluggish recovery that followed. If allowed to remain unchecked, these entities will continue posing a clear and present danger to the U.S. economy.

  • When competition declines, incentives often turn perverse, and self-interest can turn malevolent. That’s what happened in the years before the financial crisis.

  • The term TBTF disguised the fact that commercial banks holding roughly one-third of the assets in the banking system did essentially fail, surviving only with extraordinary government assistance.

  • A bailout is a failure, just with a different label.

  • The machinery of monetary policy hasn’t worked well in the current recovery.  The primary reason: TBTF financial institutions.  Many of the biggest banks have sputtered, their balance sheets still clogged with toxic assets accumulated in the boom years.

  • TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and powerful.

  • virtually nobody has been punished or held accountable for their roles in the financial crisis.

  • zero interest rates are taxing savers to pay for the recapitalization of the TBTF banks whose dire problems brought about the calamity that created the original need for the zero interest rate policy.

  • A financial system composed of more banks—numerous enough to ensure competition but none of them big enough to put the overall economy in jeopardy—will give the United States a better chance of navigating through future financial potholes, restoring our nation’s faith in market capitalism.

  • Taking apart the big banks isn’t costless.  But it is the least costly alternative, and it trumps the status quo.

  • The road to prosperity requires recapitalizing the financial system as quickly as possible. Achieving an economy relatively free from financial crises requires us to have the fortitude to break up the giant banks.

Moving back to the Dallas Fed President's letter, Fisher has not suddenly sprung this position of forced break-up of the largest banks out of thin air.  He has been speaking out on that subject, as documented by Bloomberg last November:

“I believe that too-big-to-fail banks are too-dangerous-to-permit,” Fisher said in the text of remarks given in New York today. “Downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response. Then, creative destruction can work its wonders in the financial sector, just as it does elsewhere in our economy.”

Nonetheless, it is surprising to many that this message is a focal point of a regional Fed annual report.

Here is the full letter by Fisher from the annual report (emphasis by Econintersect):

Letter from the President,

If you are running one of the “too-big-to-fail” (TBTF) banks—alternatively known as “systemically important financial institutions,” or SIFIs—I doubt you are going to like what you read in this annual report essay written by Harvey Rosenblum, the head of the Dallas Fed’s Research Department, a highly regarded Federal Reserve veteran of 40 years and the former president of the National Association for Business Economics.

Memory fades with the passage of time. Yet it is important to recall that it was in recognition of the precarious position in which the TBTF banks and SIFIs placed our economy in 2008 that the U.S. Congress passed into law the Dodd–Frank Wall Street Reform and Consumer Protection Act (Dodd–Frank). While the act established a number of new macro prudential features to help promote financial stability, its overarching purpose, as stated unambiguously in its preamble, is ending TBTF.

However, Dodd–Frank does not eradicate TBTF. Indeed, it is our view at the Dallas Fed that it may actually perpetuate an already dangerous trend of increasing banking industry concentration. More than half of banking industry assets are on the books of just five institutions. The top 10 banks now account for 61 percent of commercial banking assets, substantially more than the 26 percent of only 20 years ago; their combined assets equate to half of our nation’s GDP. Further, as Rosenblum argues in his essay, there are signs that Dodd– Frank’s complexity and opaqueness may even be working against the economic recovery. In addition to remaining a lingering threat to financial stability, these megabanks significantly hamper the Federal Reserve’s ability to properly conduct monetary policy.

They were a primary culprit in magnifying the financial crisis, and their presence continues to play an important role in prolonging our economic malaise.  There are good reasons why this recovery has remained frustratingly slow compared with periods following previous recessions, and I believe it has very little to do with the Federal Reserve. Since the onset of the Great Recession, we have undertaken a number of initiatives— some orthodox, some not—to revive and kick-start the economy. As I like to say, we’ve filled the tank with plenty of cheap, high-octane gasoline. But as any mechanic can tell you, it takes more than just gas to propel a car.

The lackluster nature of the recovery is certainly the byproduct of the debt-infused boom that preceded the Great Recession, as is the excessive uncertainty surrounding the actions—or rather, inactions—of our fiscal authorities in Washington. But to borrow an analogy Rosenblum crafted, if there is sludge on the crankshaft—in the form of losses and bad loans on the balance sheets of the TBTF banks—then the bank-capital linkage that greases the engine of monetary policy does not function properly to drive the real economy. No amount of liquidity provided by the Federal Reserve can change this.

Perhaps the most damaging effect of propagating TBTF is the erosion of faith in American capitalism. Diverse groups ranging from the Occupy Wall Street movement to the Tea Party argue that government-assisted bailouts of reckless financial institutions are sociologically and politically offensive. From an economic perspective, these bailouts are certainly harmful to the efficient workings of the market.

I encourage you to read the following essay. The TBTF institutions that amplified and prolonged the recent financial crisis remain a hindrance to full economic recovery and to the very ideal of American capitalism.

It is imperative that we end TBTF. In my view, downsizing the behemoths over time into institutions that can be prudently managed and regulated across borders is the appropriate policy response. Only then can the process   “creative destruction”— which America has perfected and practiced with such effectiveness that it led our country to unprecedented economic achievement— work its wonders in the financial sector, just as it does elsewhere in our economy. Only then will we have a financial system fit and proper for serving as the lubricant for an economy as dynamic as that of the United States.

- - - End of letter - - -

Later in the report, there’s this explainer of how Too Big To Fail is a perversion of capitalism:

TBTF: A Perversion of Capitalism

An unfortunate side effect of the government’s massive aid to TBTF banks has been an erosion of faith in American capitalism. Ordinary workers and consumers who might usually thank capitalism for their higher living standards have seen a perverse side of the system, where they see that normal rules of markets don’t apply to the rich, powerful and well-connected.

Here are some ways TBTF has violated basic tenets of a capitalist system:

  • Capitalism requires the freedom to succeed and the freedom to fail.
    Hard work and good decisions should be rewarded. Perhaps more important, bad decisions should lead to failure—openly and publicly. Economist Allan Meltzer put it this way:  “Capitalism without failure is like religion without sin.
  • Capitalism requires government to enforce the rule of law. This requires maintaining a level playing field.  The privatization of profits and socialization of losses is completely unacceptable.  TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and powerful.
  • Capitalism requires businesses and individuals be held accountable for the consequences of their actions. Accountability is a key ingredient for maintaining public faith in the economic system.  The perception—and the reality—is that virtually nobody has been punished or held accountable for their roles in the financial crisis.
  • The idea that some institutions are TBTF inexorably erodes the foundations of our market-based system of capitalism.

John Lounsbury


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1 comment

  1. Taymere says :

    This is refreshing coming from the Fed. Right now these unelected Fed banksters rule the country and scum bags like Dudley have the nerve to pressure FHA director Demarco, whose job is conservatorship, into handing his 2BTF bankster cronies a hand out in the form of principal writedowns on 1st mortgages that leave the bansksters that own the 2nd mortgages whole. That is beyond regulatory capture, the situation at the Fed is essentially that banksters nominate banksters to regulate them, no need to capture what is handed to them. And the Fed is quite corrupt, recall the insider trading by Stephen Friedman?

    This letter from Fisher is the first time I have heard anything good from a Fed bankster. I despise the rest of the Fed banksters who are interfering in politics and inflating away my savings. I own my house free and clear, it's small house but dammit it's mine. I didn't cash out refi in 2005, I sacrificed and scrimped and paid my mortgage off in 10 years. How dare these unelected banksters pressure Demarco to writedown principal, they presume to rule over us.

    The bank is, in fact, but one of the fruits of a system at war with the genius of all our institutions -- a system founded upon a political creed the fundamental principle of which is a distrust of the popular will as a safe regulator of political power, and whose great ultimate object and inevitable result, should it prevail, is the consolidation of all power in our system in one central government. Lavish public disbursements and corporations with exclusive privileges would be its substitutes for the original and as yet sound checks and balances of the Constitution -- the means by whose silent and secret operation a control would be exercised by the few over the political conduct of the many by first acquiring that control over the labor and earnings of the great body of the people. Wherever this spirit has effected an alliance with political power, tyranny and despotism have been the fruit. If it is ever used for the ends of government, it has to be incessantly watched, or it corrupts the sources of the public virtue and agitates the country with questions unfavorable to the harmonious and steady pursuit of its true interests.

    Andrew Jackson, 7th Annual Address to Congress 1835

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