A Break in the Ranks at the Fed - A Most Important Speech

The Kansas Federal Reserve President, Thomas Hoenig, representing himself, just gave one hell of a speech, Too Big Has Failed. Calculated Risk, (who found this gem), said this is a call for nationalization. Is it?

In the speech, Hoenig states:

we have not defined a consistent plan and not addressed basic shortcomings and, in some cases, the insolvent position of these institutions.

Hoenig then acknowledges while the United States is trying to avoid nationalization, it's happening anyway, slow, painful and piecemeal. He also suggests the current series of actions are adding to market uncertainty.

Hoenig describes current actions on the financial crisis, the results and offers a road map of policy suggestions.

One thing to note, Hoenig's citing of Sweden's approach to their financial crisis:

Sweden dealt firmly with insolvent institutions, including operating two of the largest banks under governmental oversight with the goal of bringing in private capital within a reasonable amount of time. To deal with the bad assets in these banks, Sweden created well-capitalized asset management corporations or what we might call “bad banks.” This step allowed the problem assets to be dealt with separately and systematically, while other banking operations continued under a transparent and focused framework.
The end result of this approach was to restore confidence in the Swedish banking system in a timely manner and limit the amount of taxpayer losses. Sweden, which experienced a real estate decline more severe than that in the United States, was able to resolve its banking problems at a long term net cost of less than 2 percent of GDP.

It looks like we're not alone in examining the history of financial crises for the best solutions.

Hoenig outlines the lessons from the past:

  • First, the losses in the financial system won’t go away – they will only fester and increase while impeding our chances for a recovery.
  • Second, we must take a consistent, timely, and specific approach to major institutions and their problems if we are to reduce market uncertainty and bring in private investors and market funding.
  • Third, if institutions -- no matter what their size -- have lost market confidence and can’t survive on their own, we must be willing to write down their losses, bring in capable management, sell off and reorganize misaligned activities and
    businesses, and begin the process of restoring them to private ownership.

He is clearly calling for a new solution, a temporary nationalization of the failed banks.

He also gives some details or conditions for reconstruction.

  • First, public authorities would be directed to declare any financial institution insolvent whenever its capital level falls too low to support its ongoing operations and the
    claims against it, or whenever the market loses confidence in the firm and refuses to provide funding and capital. This directive should be clearly stated and consistently adhered to for all financial institutions that are part of the intermediation process or payments system. We must also recognize up front that the FDIC’s resources and other financial industry support funds may not always be sufficient for this task and that Treasury money may also be needed.
  • Next, public authorities should use receivership, conservatorship or “bridge bank” powers to take over the failing institution and continue its operations under new management. Following what we have done with banks, a receiver would then take out all or a portion of the bad assets and either sell the remaining operations to one or more sound financial institutions or arrange for the operations to continue on a bridge basis under new management and professional oversight. In the case of larger institutions with complex operations, such bridge operations would need to continue until a plan can be carried out for cleaning up and restructuring the firm and then reprivatizing it.
    Shareholders would be forced to bear the full risk of the positions they have taken and suffer the resulting losses. The newly restructured institution would continue the essential services and operations of the failing firm.

So, nicely worded but this is the fundamental issue, someone somewhere is supposed to take the loss and by the rules of capitalism that should be the corporate management and the shareholders, not the taxpayer.

Let's hope other Federal Reserve chairs as well as government officials listen to this pragmatic and common sense view.

It's a shame we do not have a video of the speech itself, here again is the entire text.




Volcker makes sense

He has a plan for a global system, twin peaks on market regulation as well.

When I first heard of Volcker I was like "oh God, that Reagan guy from the 80's who sent interest rates to the stratosphere" but he's turning out to really know what he's talking about.

Too bad he doesn't continue to localization

Which seems to me to be a missing step in all of this. A huge part of the problem is not economical, but anthropological- the bankers and traders in New York and other big cities have become culturally distinct from either industry or agricultural interests- and as such see the other segments of our society as marks for their con game.

A solution to that problem, and one I was hoping to see in a speech entitled "Too Big Has Failed", is localization. You see, the problem with simply nationalizing and creating the "Bad Bank" method is that it doesn't go far enough- it doesn't return control of the money to local communities. But if, in the process of breaking up the bad bank, you reduce the cross-border investment and sell the bad assets in their local communities, then you inject into the market a willingness to uphold the contract on one side, and a willingness to write down the contract on the other side, under the guise of helping one's neighbor (and supposedly, a person one runs into often at community events).

Otherwise "Too Big has Failed" might get fixed, but will just continue to roll over into a whole new "Too Big" get rich quick scheme.

Moral hazards would not exist in a system designed to eliminate fraud.

Maximum jobs, not maximum profits.