Fed's Hoenig Says U.S. Should Break Up Largest Financial Firms

Federal Reserve Bank of Kansas City President Thomas Hoenig said U.S. regulators should avert another crisis by breaking up large financial institutions that pose a threat “to our capitalistic system.”

“I am convinced that the existence of too-big-to-fail financial institutions poses the greatest risk to the U.S. economy,” Hoenig said today in a speech in Washington. “They must be broken up. We must not allow organizations operating under the safety net to pursue high-risk activities and we cannot let large organizations put our financial system at risk.”

Hoenig, the lone dissenter from every Fed meeting in 2010, has argued that the most sweeping overhaul of U.S. financial regulation since the Great Depression won’t prevent the largest banks from taking excessive risks and increasing market share. Regulators, including the Fed, are implementing the law.

“In my view, it is even worse than before the crisis,” Hoenig said at a luncheon for Women in Housing and Finance. “As well-intentioned as the Dodd-Frank Act may be, it will not improve outcomes,” he said.

The Dodd-Frank Act, named after its chief sponsors Massachusetts Representative Barney Frank and former Connecticut Senator Chris Dodd, both Democrats, created a resolution authority to unwind the largest financial institutions. It also adopted the Volcker rule, which aims at reducing the odds that banks will make risky investments and put their federally insured deposits at risk.

‘Public Purse’

“Protected institutions must be limited in their risk activities because there is no end to their appetite for risk and no perceived end to the public purse that protects them,” Hoenig said.

The Financial Stability Oversight Council, established under the legislation, is working to flesh out the Volcker rule.

“We must break up the largest banks, and could do so by expanding the Volcker rule and significantly narrowing the scope of institutions that are now more powerful and more of a threat to our capitalistic system than prior to the crisis,” Hoenig said.

The Kansas City Fed chief cited research from the regional bank indicating that large banks enjoyed savings of 1.6 percentage points on debt with a two-year maturity and over 3.6 percentage points for seven-year debt.

“In a competitive marketplace, where just a few basis points make a difference, these funding advantages are huge and represent a highly distorting influence within financial markets,” he said.

Economic Outlook

In response to audience questions, Hoenig said the Fed’s monetary policy “invites speculation” with its current pledge to keep interest rates low for an “extended period.”

Hoenig cited the case of rising farmland values. The Chicago Federal Reserve reported last week that the price of such land rose 12 percent in the fourth quarter of 2010 from a year earlier. In Congressional testimony last week, Hoenig said the Kansas City Fed has recorded farmland prices nearly 20 percent above year-earlier levels in Kansas and Nebraska.

The Fed’s policy is “encouraging asset buildups,” Hoenig said. “My point is monetary policy isn’t just about inflation,” he said, it’s also “about asset values.”

Fed presidents rotate voting on monetary policy and Hoenig, 64, will not vote this year. He joined the Kansas City Fed in 1973 as an economist in banking supervision after earning his doctorate at Iowa State University. Hoenig became president of the Kansas City Fed in 1991.

“The substantial incentives that large organizations have to take on more risk, with the government expected to pick up the losses should they incur, unfailingly lead to undue risks throughout the balance sheet,” he said.

To contact the reporters on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net.

To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net

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