“The new Minneapolis Fed President and his team recently calculated that under pre-crisis regulations (bank capital rules set by the government, not by bankers) there was an 84% chance of a crisis requiring taxpayer bailouts over a 100-year period…

…This jives perfectly with what former Fed Chairman Greenspan said in his paper, “The Crisis”, where he said that “central bankers deliberately set bank capital levels at a level that did not account for the once-or-twice in a century financial crisis and as a result, sovereign governments must step in and provide capital to the banking system, at those times.” So the truth is revealed. How can private bankers like myself, following all of the pre-crisis government banking rules and regulations, be blamed for our bank’s failing, when most Too Big to Fail Banks would have also failed, if they had not been bailed out with government capital, government loans, and the government’s bailout and/or guarantees of otherwise insolvent Fannie Mae, Freddie Mac, FHA, the FDIC, private mortgage insurers, and money market funds? It’s outrageous and un-American what happened to bankers like myself.”, Mike Perry, former Chairman and CEO, IndyMac Bank

“Minneapolis Fed President Neel Kashkari is proposing that the biggest banks vastly increase the amount of equity capital they hold. The plan doesn’t require any big banks to shrink, merely to raise more capital over five years so that it reaches 15% of assets. At that point, if the Treasury Secretary refuses to certify that a giant bank is no longer a systemic risk, capital would rise to 24%. By contrast the Fed now requires 5%. The practical implication is that some banks would shrink on their own unless the economies of scale are valuable enough to justify their size. Mr. Kashkari and his team want to make the chances of a bailout extremely small. They calculate that under the pre-crisis regulations there was an 84% chance of a crisis requiring taxpayer bailouts over a 100-year period, and that Dodd-Frank reduced that risk only to 67%. They want a plan that would bring the risk below 10% while still passing a cost-benefit test, and they claim to have done it. Let the debate over statistics and methodology begin.”, “Cash and Kashkari”, The Wall Street Journal Editorial Board, November 22, 2016

Opinion

Cash and Kashkari

The consensus grows that Dodd-Frank won’t stop the next financial crisis.

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Neel Kashkari, president and chief executive officer of the Federal Reserve Bank of Minneapolis, speaks at the Economic Club of New York in New York, U.S., on Wednesday, Nov. 16, 2016. PHOTO: BLOOMBERG NEWS

As President Obama prepares to leave town, the world is learning that his reforms aren’t holy writ. The latest evidence is Minneapolis Federal Reserve President Neel Kashkari’s plan to end too-big-to-fail banks.

Mr. Kashkari, who rolled out his proposal last week, starts with an understanding that the 2010 Dodd-Frank Act’s vast regulatory superstructure isn’t the protector of taxpayers that its authors claim. “I start with the assumption that regulators are going to miss the next crisis,” he said in a visit to the Journal. “We’re going to miss it.”

That’s refreshing modesty in a federal regulator, and it has the added advantage of being true. Financial manias become panics because everyone assumes there’s no problem while the good times roll. Exhibit A was the New York Fed’s failure to rein in Citigroup’s off-balance sheet vehicles before the 2008 panic. Tim Geithner’s Fed regulators were as clueless as anyone.

Mr. Kashkari knows the territory. A Goldman Sachs alum, he helped design and implement the Troubled Asset Relief Program for Treasury Secretary Hank Paulson in 2008. The Minneapolis Fed chief was also in the room in 2008 when federal officials decided to make taxpayers stand behind the subordinated debt of mortgage monsters Fannie Mae and Freddie Mac—though that debt was never supposed to be guaranteed.

The lesson he drew is that if you want to reduce the risk that taxpayers will have to finance another rescue, financial giants need to be much better fortified before the next panic hits. And that means they need to have much more equity and less debt.

He is proposing that the biggest banks vastly increase the amount of equity capital they hold. The plan doesn’t require any big banks to shrink, merely to raise more capital over five years so that it reaches 15% of assets. At that point, if the Treasury Secretary refuses to certify that a giant bank is no longer a systemic risk, capital would rise to 24%. By contrast the Fed now requires 5%. The practical implication is that some banks would shrink on their own unless the economies of scale are valuable enough to justify their size.

Mr. Kashkari and his team want to make the chances of a bailout extremely small. They calculate that under the pre-crisis regulations there was an 84% chance of a crisis requiring taxpayer bailouts over a 100-year period, and that Dodd-Frank reduced that risk only to 67%. They want a plan that would bring the risk below 10% while still passing a cost-benefit test, and they claim to have done it. Let the debate over statistics and methodology begin.

There should be skepticism about other parts of the Kashkari plan, such as his maintenance of much of the existing regulatory structure and his desire to control large financial firms that aren’t banks. Bank regulators call these firms “shadow banks,” meaning every finance business they don’t control. But there’s no reason to make taxpayers stand behind hedge funds.

We prefer the trade-off between capital and regulation offered by House Financial Services Chairman Jeb Hensarling, who would give banks the choice of raising more capital in return for less Dodd-Frank micromanagement. Mr. Kashkari says that may well be the result down the road of his plan too. The larger point is that a consensus is growing that Dodd-Frank is flawed and has stymied economic growth without making the financial system safer. The Kashkari plan is a welcome addition to this debate.

Posted on November 30, 2016, in Postings. Bookmark the permalink. Leave a comment.

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