Last week, the president of the Federal Reserve Bank of Dallas, Richard Fisher, launched his most ferocious attack yet against what he now calls the “pathology” of big banks. He issued a call to arms to break them up, promising that an accompanying study would include the how-to. On examination, though, neither the speech nor the study does much more than recommend a separation of banking from all the activities already segregated from it by the excoriated Gramm-Leach-Bliley Act. To be sure, Mr. Fisher toughens this regime up a bit, but pretty much everything he wants could be done now by the FDIC and Fed if Mr. Fisher’s colleagues agreed with him. Thus, for all its rhetoric, the Fisher plan isn’t particularly radical, nor would it create the desired chasm between nice banking and all the evil Mr. Fisher thinks big banks do.
What’s the Fisher plan? So far as I can tell, it rests on two planks. The first is to separate banking into a few activities protected by a federal safety net and a lot of stuff supposed to stand on its own. What goes where? The details on this critical question are, at best, scant. However, the concept appears to be that taking insured deposits and making loans gets FDIC coverage and access to the Federal Reserve discount window. Broker-dealer, insurance, finance-company and other unspecified non-banking activities are to be shoved from their supposed cocoon. Then, the second key proposal: demand a “covenant” from customers so that all clearly know that these products are outside the safety net.
The first thing wrong with this concept is the view that the FDIC protects banks and, thus, spreads its comfy net below all sorts of evil-doing. In fact, deposit insurance is for depositors, not banks. But, the higher the limit and the more customers are allowed to evade them through brokered deposits, the less market discipline is exerted on insured depositories. Much in Mr. Fisher’s speech and study extols community banks, but it is they – not the largest institutions – that have fought hard for unlimited deposit insurance. For Mr. Fisher’s concept to work, he would need to go a lot tougher on his community-bank charges. Simply put, the broader the FDIC net, the less care depositors need to take, the more funds flow into high-risk institutions, the wilder the loans banks need to make to cover these costs and… the rest is history a la the S&L crisis of the 1980s, Indy Mac, WaMU, etc., etc., etc.
So, if one wants to curtail the FDIC safety net – which I do – the best way is to limit coverage to small amounts for depositors who cannot reasonably be expected to fend for themselves – precisely what Congress intended in 1933. This of course wasn’t done during the 2008 crisis, when the FDIC leapt into the fray not only with unlimited coverage for depositors, but also the temporary liquidity guarantee program that spread the safety net fully below institutional debt-holders. Title XI of Dodd-Frank rightly bars any repeat performances by the FDIC, as well as future extensions of the Federal Reserve’s liquidity facilities to insolvent banking organizations. Nowhere does Mr. Fisher grapple with these reforms, which go a lot farther, faster in curtailing the safety net than anything he has yet proposed.
Mr. Fisher might counter that strict FDIC limits and greater FRB discipline don’t resolve risk because protected activities can morph into risky ones. He thus argues that the activities cited above should be defenestrated from insured depositories. But, mostly they already are. The OCC has allowed more integration within national banks than Mr. Fisher might like, but much of this is forced into “financial subsidiaries” insulated from the bank and the rest of it is grandfathered activities defended at least as strongly by community banks as by the big ones the Dallas Fed castigates.
Both the Bank Holding Company Act and Gramm-Leach-Bliley forced most of the activities Mr. Fisher cites into holding-company subs precisely to ring fence them from the insured depository and exclude them from the discount window. If they have gotten de facto protection, it’s largely due to the fact that bank regulators and the FRB haven’t used the powers they’ve got to separate firms as decisively as possible.
The most important powers here are found buried in Sections 23A and 23B of the Federal Reserve Act, provisions long in the law books and toughened up by Gramm-Leach-Bliley and, now, by Dodd-Frank. The point of these inter-affiliate transaction restrictions – unique to the U.S. – is to limit the degree to which insured deposits can fund non-bank activities in a holding company and/or provide an unfair subsidy that allows BHCs to out-compete stand-alone financial-services firms. The U.S. doesn’t have universal banks largely because of these barriers, as well as the holding-company restrictions and an array of additional product restrictions that separate banking from commerce. Why this isn’t good enough to achieve the break-up goal is never made clear in the Dallas plan.
I know of no better way to limit the safety net and control complexity than to give deposit-insurance protection only to low-balance retail depositors and to enforce Sections 23A and 23B. Back to you, Mr. Fisher.