What Is Missing In the TBTF Discussion?

Written by Dwight Haskins

The topic of TBTF has taken a central place in discussions about the future of banking and appropriate policy measures needed to regulate the industry. TBTF is being discussed, in my opinion, without a seriousness consideration of why having a handful of banks with vast influence over national capital markets can only lead to trouble for our national economy and our society. An open discussion amongst legislators is not happening due to political influences of the largest banks and their lobbying groups, combined with the deeply institutionalized power held by largest handful of banks.

The Dodd-Frank Act is an attempt to prevent another crisis but it fails to address poorly designed regulatory surveillance and examination processes that were built for a much simpler banking industry. Current regulatory processes need to be restructured to better execute preventive crises and need to develop rapid response measures to ward off a crisis at the first sign of trouble. There have been too few workshops and conferences by regulators or other organiza­tions to explore the technical reforms needed in the banking industry, and how to harness the power of large banks over the rest of the industry. Instead, the largest banks and their lobbyists have been major proponents in their own right, with seemingly little interest in Main Street or to see that the public does not suffer from consequences of a deeply fractured banking industry.

Instead of concentrating efforts on lobbying, large banks need to expand their efforts in more inclusionary advocacy; public education on crisis prevention; sponsorship of financial crisis prevention research; analysis of crisis prevention concepts, techniques, tools, and trends. The largest handful of banks need more direct engagement in identifying early warning of emerging risks; local capacity building by all banks to prevent an economic crisis; dissemination of information to the public; training of development of risk employees in the banks, including joint participation with staff from the bank regulatory agencies; and better and more direct communication of operations and risks to regulators, investors and to the public. These types of broad-based changes are necessary if we are serious in preventing the next crisis.

The largest banks need to embrace the “do no harm” prin­ciple in their advocacy and planning efforts.

Moreover, expansion of regulations and size of agencies devoted to crisis prevention is not the panacea. The quality of regulatory supervision and research is paramount. On one hand, we need to ensure regulators have a more sophisticated set of practical risk surveillance and conceptual tools if we hope to identify and head off emerging risks before it becomes too late to take action. On the other hand, burgeoning research has created considerable confusion over terminology and necessary regulatory response measures. We need more participation and consideration of national thought-leaders and academics in banking, finance, economics and psychology to narrow the divide.

Effective crisis prevention should include: conflict analysis, early warning, operational capacity, strategy, institutional capacity, and political will. Each constitutes a link in the “chain” of prevention, which is only as strong as the weakest of the links. Sadly, political will appears today to be the weak link.

Preventive action depends on identifying the root causes of an emerging or imminent conflict. If either of these levels of analysis is flawed, then preventive measures will either miss key warning signs and hence miss opportunities for early action, or will correctly foresee conflicts but misread their nature and hence apply the wrong tools.

There is the perennial problem of securing accurate information on which to base analysis and action. Even in benign periods, key indicators of “systemic causes” of economic crisis, such as declining gross national product per capita or unemployment, are often inaccurate or crude. Moreover, access to reliable information worsens in direct rela­tionship to the deterioration of politics; and polarized politics hamper independent information-gathering and politicize the views of all with a voice.

We need a better understanding of the “root” causes of financial crises and what role does poverty, “regulatory and political capture” by outside influences, and uneven distribution of resources play. Broader social concerns are not being dealt with although intertwined with banking policy. By ignoring the underlying factors we are only addressing the symptoms rather than the causes of financial crises.  We know that measures need to be taken towards reducing economic poverty by lifting up the working poor and by achieving broad-based economic growth. This has to be a step toward future conflict and crisis prevention. Preventive strategies must therefore work to promote human rights, to protect minority rights and to institute political arrangements in which all groups in our nation are represented.

As we have come to learn, the predictive value of our models of “systemic causes of conflict” progressively diminishes as conflicts move from emerging to imminent. At that point, precipitating causes become paramount, and precipitating causes are much more likely to be driven by capri­cious decisions and unforeseeable, random events that defy prediction. Moreover, as crises mount, decision makers invariably encounter fiercely competing interpretations of events, both from internal analysts and policy wonks and from external analysts. The considerable energies now being devoted to improving the capacity to predict crises or conflict will no doubt yield some fruit. But it is important not to overstate the ability to predict. As the recent crisis has shown us, herd behavior on the part of regulators and blind spots can make even the most elaborate risk models worthless in predicting a crisis.

Simply put, we need more humanitarian and development work through a “conflict prevention lens” as a means to a more integrated, holistic approach to regulating banks and for crisis prevention.  There is logic to the argument that root causes should be addressed if social conflict and crises are to be prevented. We cannot afford to wait until conflict is imminent as we have learned from the most recent crisis how a late regulatory response lowers any chance of success. Broadening the definition of both conflict and crisis prevention to include economic development, inclusion of all members of society and better governance issues is appro­priate.

A broader understanding of TBTF consequences on society and more elastic definition of financial crisis to equate financial crisis prevention with correction of economic and social inequities will make our nation a beacon of light.