NEW YORK – Efforts to prevent another fiscal crisis seem to be more “rhetoric” than “substance and necessary reform,” Federal Reserve Bank of Kansas City President Thomas M. Hoenig said today.
“As a nation, we have violated the central tenants of any successful system. We have seen the formation of a powerful group of financial firms. We have inadvertently granted them implied guarantees and favors, and we have suffered the consequences,” he told a U.S. Chamber of Commerce conference today, according to prepared text of his remarks, which were released by the Fed. “We must correct these violations. We must reinvigorate fair competition within our system in a culture of business ethics that operates under the rule of law. When we do this, we will not eliminate the small businesses’ need for capital, but we will make access to capital once again earned, as it should be.”
The seeds of the crisis, he said, were planted in the 1980s when interstate banking restrictions were eased, allowing formation of huge financial institutions, but there was no “framework that would limit dangerous excesses or the development of perverse incentives. Undoubtedly, the most important omission was a way to deal with the larger firms that were using the new growth opportunities to become `too big to fail (TBTF).’”
Hoenig pointed to a 1999 speech he made, where he concluded, “To the extent these institutions become ‘too big to fail,’ and … uninsured depositors and other creditors are protected by implicit government guarantees, the consequences can be quite serious. Indeed, the result may be a less stable and a less efficient financial system.” All he can add now, he said, is “government guarantees are no longer just implicit. Actions during the financial crisis have made this protection quite explicit.”
Although “the market is slowly correcting, and credit growth is or will begin flowing to Main Street, providing job growth and economic recovery,” it is neither rapid nor easy, Hoeing said.
He called for “fundamental changes that reverse the wrong-headed incentives, change behavior and reinforce the structure of our financial system. These changes must be made so that the largest firms no longer have the incentive to take too much risk and gain a competitive funding advantage over smaller ones. Credit must be allocated efficiently and equitably based on prospective economic value. Without these changes, this crisis will be remembered only in textbooks and then we will go through it all again.”
He said firms must be allowed to fail in an orderly way to stop incentivizing the largest financial institutions to take on excess risk. Supervision of financial firms must include maximum leverage and loan-to-value ratios rules, Hoenig added. Also the regulatory framework must be strengthened, he said, backing a form “of the proposed Volcker rule,” which “should focus on banning financial holding companies from proprietary trading and investing in or sponsoring hedge funds, and require trading and private equity investment to be housed in separately capitalized subsidiaries subject to strict leverage and concentration limitations. In addition, I strongly support increasing the transparency in financial markets by requiring standardized derivative transactions to be cleared through centralized counterparties, and to the extent feasible, traded on exchanges.”
