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Fed's Kashkari: Time to end 'too big to fail'

Former overseer of TARP bailout suggests breaking up big banks

Wall Street

The fundamental shifts in the country’s economic policy in the wake of the economic crisis were not enough to prevent another catastrophic meltdown and more needs to be done to ensure that a future economic downturn doesn’t turn into another crisis, Neel Kashkari, the newly minted President of the Federal Reserve Bank of Minneapolis, said Tuesday.

Speaking Tuesday at the Brookings Institution, Kashkari, who took over as Minneapolis Fed president on Jan. 1, said that the reforms enacted as part of the Dodd-Frank Act have strengthened the country’s economic system, but feels that Dodd-Frank didn’t go far enough.

According to Kashkari, it’s time to end “too big to fail,” because the size of the nation’s largest banks place them at risk of needing another bailout.

“I believe the biggest banks are still ‘too big to fail’ and continue to pose a significant, ongoing risk to our economy,” Kashkari said.

“Enough time has passed that we better understand the causes of the crisis, and yet it is still fresh in our memories,” Kashkari continued. “Now is the right time for Congress to consider going further than Dodd-Frank with bold, transformational solutions to solve this problem once and for all.”

Kashkari, who oversaw the Department of the Treasury’s Troubled Assets Relief Program during the housing crisis, announced Tuesday that the Federal Reserve Bank of Minneapolis will develop a plan to end “too big to fail” and address the risks presented by the megabanks.

In his speech, Kashkari said that he is “skeptical” that the regulations placed on the megabanks in the wake of the financial crisis, including holding more capital, have improved the strength of the banks but have not gone far enough.

“Although TBTF banks were not the sole cause of the recent financial crisis and Great Recession, there is no question that their presence at the center of our financial system contributed significantly to the magnitude of the crisis and to the extensive damage it inflicted across the economy,” Kashkari said.

“Given the scale of job losses, home foreclosures, lost savings and costs to taxpayers, there is widespread agreement among elected leaders, regulators and Main Street that we must solve the problem of TBTF,” Kashkari continued. “We know markets make mistakes; that is unavoidable in an innovative economy. But these mistakes cannot be allowed to endanger the rest of the country.”

Kashkari argues that big banks should be able make mistakes, even “big mistakes,” without requiring taxpayer bailouts and without causing widespread economic damage.

Kashkari said that in 2008, the government was left with no choice but to bailout the banks, but wants to ensure it doesn’t happen again.

Kashkari compares the 2008 bank bailouts to a nuclear reactor that is melting down.

“The cost to society of letting a reactor melt down is astronomical,” Kashkari said. “Given that cost, governments will do whatever they can to stabilize the reactor before they lose control.”

Kashkari said that the new financial regulations placed on banks should help if one large bank “runs into trouble” independent of any larger economic issues, but notes that the results of Fed stress testing have revealed “significant shortcomings,” with the government the requiring the banks to “try once again to make themselves able to fail without massive fallout.”

Kashkari said that until this work is complete, the country must acknowledge that the largest banks are still “too big to fail.”

Kashkari also suggests that the new capital rules may not be enough to withstand a larger economic downturn.

“Given the massive externalities on Main Street of large bank failures in terms of lost jobs, lost income and lost wealth, no rational policymaker would risk restructuring large firms and forcing losses on creditors and counterparties using the new tools in a risky environment, let alone in a crisis environment like we experienced in 2008,” Kashkari said.

“They will be forced to bail out failing institutions—as we were,” he continued. “We were even forced to support large bank mergers, which helped stabilize the immediate crisis, but that we knew would make TBTF worse in the long term.”

Kashkari said that he feels that several options should be considered for ending “too big to fail,” including:

  • Breaking up large banks into smaller, less connected, less important entities
  • Turning large banks into public utilities by forcing them to hold so much capital that they virtually can’t fail (with regulation akin to that of a nuclear power plant)
  • Taxing leverage throughout the financial system to reduce systemic risks wherever they lie

“Options such as these have been mentioned before, but in my view, policymakers and legislators have not yet seriously considered the need to implement them in the near term,” Kashkari said.

“They are transformational—which can be unsettling. The financial sector has lobbied hard to preserve its current structure and thrown up endless objections to fundamental change,” he continued. “And in the immediate aftermath of the crisis, when the Dodd-Frank Act was passed, the economic outlook was perhaps too uncertain to take truly bold action. But the economy is stronger now, and the time has come to move past parochial interests and solve this problem. The risks of not doing so are just too great.”

Kashkari said that many have argued against this kind of widespread systemic change, including that multinational corporations need global banks, that large banks benefit society by creating economies of scope and scale, and that limiting the size of U.S. banks could put them at a disadvantage compared to banks in country’s with looser regulations, but said that he finds those arguments “unpersuasive.”

Kashkari said that given the complexity of this issue, any “bold” plan will be “imperfect,” but that’s not a reason to do nothing.

“If we are serious about solving TBTF, we cannot let (concerns about the plans) paralyze us,” Kashkari said.

“Any plan that we come up with will be imperfect,” he continued.

“Those potential shortcomings must be weighed against the actual risks and costs that we know exist today,” Kashkari added. “Perfect cannot be the standard that we must meet before we act. Better and safer are reasons enough to act. Otherwise we will be left on the default path of incrementalism and the risk that we will someday face another financial crisis without having done all that we could to protect the economy and the American people.”

Kashkari said that the Minneapolis Fed will host a number of policy symposiums to explore various options from “expert researchers” around the country, as well as inviting leaders from policy and regulatory institutions and the financial industry to offer their views.

Kashkari acknowledges that the Fed can only present a plan to Congress, which would then have to act to authorize any systemic changes, but said that better options need to be considered.

“Congress created the Federal Reserve System to help prevent financial crises from inflicting widespread damage to the U.S. economy,” Kashkari said. “Doing everything we can to address the systemic risks posed by large banks will be an important step to fulfilling that mission. Seven years after the crisis, I believe it is now time to move forward and end TBTF.”


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