By Simon Johnson
To fix a broken financial system – and to oversee its proper functioning in the future – you need experts. Finance is complex and the people in charge need to know what they are doing. One common problem, which is also manifest in the United States today, is that many of the leading experts still believe in some version of business-as-usual.
At the height of the Great Depression, Marriner S. Eccles was summoned to Washington from Utah – where he was a regional banker. He helped remodel the Federal Reserve through the Banking Act of 1935 and then became its first independent chairman – the Fed board had previously been chaired by the Treasury Secretary. Eccles was not a fan of big Wall Street firms and their speculative stock market operations; rather he understood and identified with smaller banks that lent to real businesses. Eccles was the right kind of expert for the moment. Who has the expertise to play this kind of role in our immediate future?
Tom Hoenig, formerly president of the Kansas City Fed, has long been a strong voice for financial sector reform along sensible lines. Within the official sector, he has spoken loudest and clearest on the most important defining issue: Too Big To Fail is simply too big. And last week he took a major step towards a more prominent role, when he was announced as the administration’s nominee to become vice-chair at the Federal Deposit Insurance Corporation (FDIC).
The FDIC is not as powerful as the Fed. But in our current financial arrangements, it does have a critical role to play. The Dodd-Frank legislation has its weaknesses, but it gives the FDIC two important powers. First, with regard to big banks, the FDIC can help force the creation of credible “living wills” – explaining how the bank can be wound-down if necessary. If such wills are not plausible then, in principle, the FDIC could force simplification or divestiture of some activities. Second, the FDIC is now in charge of “resolution” for megabanks, i.e., actually closing them down and apportioning losses in the event of failure.
One important concern is whether the FDIC has enough clarity of thought and – most critically – enough political support in order to take the preemptive actions needed to make our biggest banks smaller and safer. (For more specific suggestions – and some disagreement – on what exactly is required to strengthen financial stability, you can watch two speeches from Friday at a George Washington law school symposium; Sheila Bair, the former FDIC chair, spoke first and I spoke immediately after; my remarks start around the 49 minute mark).
The FDIC senior team is already strong, with a great deal of experience handling the problems of small and mid-size banks. The current acting chairman, Martin J. Gruenberg, was vice chair under Sheila Bair. These are not people who are easily intimidated by big banks. And Mr. Gruenberg is highly regarded on Capitol Hill, where he worked on the Senate Banking Committee for nearly two decades. (Disclosure, I’m on the FDIC’s Systemic Resolution Advisory Committee, which meets in public; I’m not involved in any personnel or policy decisions.)
I have been a strong supporter of Mr. Hoenig in recent years, endorsing his views and arguing in the past that he should become Treasury Secretary.
In the current mix of Washington-based policymakers, Mr. Hoenig would be a great addition. He spoke out early and often against Too Big To Fail banks. In early 2009 His paper “Too Big Has Failed” became an instant classic. It is worth reading again because it contains a number of forward-looking statements that remain important today. Perhaps the most relevant for his FDIC role,
“[S]ome are now claiming that public authorities do not have the expertise and capacity to take over and run a “too big to fail” institution. They contend that such takeovers would destroy a firm’s inherent value, give talented employees a reason to leave, cause further financial panic and require many years for the restructuring process. We should ask, though, why would anyone assume we are better off leaving an institution under the control of failing managers, dealing with the large volume of “toxic” assets they created and coping with a raft of politically imposed controls that would be placed on their operations?”
This sounds very much like the basis for a sensible strategy of thinking about Bank of America, which is in serious trouble – and where the FDIC should consider a more pro-active intervention.
The European debt situation is also threatening to spiral out of control, with potentially serious consequences for our financial sector. If you have not yet reviewed the details of Bill Marsh’s graphic from Sunday’s New York Times, I strongly recommend that you do so – but you’ll need a big computer screen or the ability to print out on a very large piece of paper (The picture is literally big, 18×21 inches; there is also a nice interactive version, which lets you look at various scenarios).
We do not know how these or other shocks will hit our financial system. Nor do we know exactly who will fall into what kind of trouble.
We need experts at the helm with sensible judgment and the right priorities – and with a good understanding of what kind of financial system we really need. We also need policymakers who have strong support from across the political spectrum, including on Capitol Hill.
Tom Hoenig is exactly the right person for the moment.
An edited version of this post appeared this morning on the NYT’s Economix blog; it is used here with permission. If you would like to reproduce the entire post, please contact the New York Times.