Econintersect: Federal Reserve Bank of Dallas President Richard W. Fisher gave a simple solution to the TBTF (too big to fail) risk to the financial system. He gave his views speaking before the Committee for the Republic Wednesday 16 January 2013.
Fisher claimed that his proposal was much simpler than the expanded regulation regimes of Dodd-Frank implementation. Fisher’s view of the structure of a typical TBTF banking organization had the following organization chart:
Click on graphic for larger image.
The graphic that explains Fisher’s proposal is pretty easy to understand:
Why does this seem so simple? Could it be because it seems to overlay pretty well with an act passed and implemented in 1933, known as the Glass-Steagall Act (GSA). Under this regime 50 years of banking stability ensued, probably the longest such time span in the country’s history.
GSA effectively isolated commercial depository banking from all other forms of financial institutions (often called shadow banking). Only the narrowly defined depository institutions enjoyed government sponsored guarantees, such as the FDIC (Federal Deposit Insurance Corporation).
The effectiveness of GSA came into question when the seventh largest bank in the country failed in 1984. Continental Illinois bank was the largest bank failure in U.S. history until succeeded in that distinction by Washington Mutual in the Great Financial Crisis (GFC) of 2008.
The failure of Continental Illinois was claimed by opponents of GSA to prove their thesis that the 1933 law was diminishing the freedom of action that could have diversified risks that had led to the bank’s failure. However the failure was caused by a combination of (1) poor due diligence by the bank in acquiring assets that proved to be bad loans (what were called “toxic assets” in the GFC) and (2) lax regulatory activity.
Eventually criminal convictions resulted for bank officials accused of fraud and accepting bribes. GSA was not ineffective – enforcement by banking regulators and inspectors was not sufficient, i.e. implementation of the law had become lax.
However, eventually GSA was repealed with the enactment of the Gramm-Leach-Bliley Act (GLBA) in 1999 and the U.S. was off and running to the banking structures shown in the graphic above.
Fisher proposed the solution to TBTF problems would be obtained by severing the umbilical cord that all banks, even the super sized mega banks, have to the government. Only the commercial depository banks would have FDIC membership and access to the Fed “window” for reserves and liquidity management. This is shown in the following in the second graphic shown earlier.
Fisher says that he would legally require that all entities and persons doing business with any shadow banking institution be required to sign the following:
Clearly Fisher believes that the law of the jungle will take care of any financial institutions who do not streamline into efficient self-sufficient businesses.
Read the full speech.
- Ending ‘Too Big to Fail’: A Proposal for Reform Before It’s Too Late (With Reference to Patrick Henry, Complexity and Reality) (Speech by Richard W. Fisher, Federal Reserve Bank of Dallas)
Hat tip to The Big Picture.