Fed’s Hoenig Sees Economic Danger in Big Financial Firms

Federal Reserve Bank of Kansas City President Thomas Hoenig said the existence of companies whose failure would threaten the financial system is an obstacle to economic growth and impedes competition.

Companies deemed systemically important financial institutions, or SIFIs, “are fundamentally inconsistent with capitalism,” Hoenig said today in a speech in Washington. “They are inherently destabilizing to global markets and detrimental to world growth.”

The remarks by Hoenig, who has previously called for the breakup of the biggest financial firms, are among his strongest as he nears the end of his two-decade tenure as a Fed policy maker. He said policy makers “must go beyond” the Dodd-Frank Act of 2010 overhauling regulation, including by shrinking the government’s safety net.

“So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, the future of capitalism is at risk and our market economy is in peril,” Hoenig said at an event hosted by the Pew Financial Reform Project and New York University Stern School of Business.

Hoenig spoke after international regulators forged an agreement over the weekend that requires the world’s largest banks to hold extra capital. The requirement is aimed at strengthening the biggest banks’ financial cushions to prevent another financial crisis.

Extra Capital

Banks considered systemically important would be required to hold between 1 percentage point and 2.5 points of extra capital as a proportion of their risk-weighted assets. That’s on top of the 7 percent capital buffer required for all internationally active banks.

Responding to an audience question, Hoenig said the surcharge may not reduce risks to the broader financial system, compared with his recommendations.

“I don’t have any faith in it at all,” he said. Discussing the Dodd-Frank law’s authority for the government to wind down a failing big firm without a bailout, Hoenig said, “I just can’t imagine it working.”

Hoenig noted in his speech that the biggest banks say they shouldn’t be held to tougher capital standards for the U.S. to “remain globally competitive,” calling that view “nonsense.”

The Kansas City Fed chief also reiterated his recommendations to restrict banks to loans and deposits and to allow money market mutual funds to have a floating net asset value instead of being allowed to maintain a fixed value of $1.

Overhaul Law

Last month, Hoenig said provisions of the Dodd-Frank Act, the financial overhaul law enacted last year, would help put banks on a stronger financial footing to prevent another crisis.

Specifically, he spoke of his support for the Volcker Rule, named for former Fed Chairman Paul Volcker. The provision, contained in the new law, would force bank holding companies to cease bets with their own money outside of traditional lending.

Hoenig’s proposals would result in separating primary dealers, which help the Fed carry out monetary policy, from commercial banks. The change “would have little effect” on the Fed’s ability to manage interest rates, he said.

The central bank could use a former emergency tool called the Term Auction Facility, which provided loans to banks for about one to three months starting in late 2007, in conjunction with primary dealer operations, Hoenig said.

Set to Retire

Hoenig, who is set to retire on Oct. 1, is not a voting member this year on the Federal Open Market Committee. As a voting member last year, he opposed the Fed’s decision on Nov. 3 to launch the $600 billion bond-buying program, its second effort to stimulate the economy through so-called quantitative easing.

He also objected to the Fed’s decisions throughout last year to hold interest rates at record lows for an “extended period.” Hoenig has expressed concern that those decisions could kindle inflation and lead to a wave of speculative buying on Wall Street. Hoenig cast dissenting votes at each of the Fed’s eight meetings last year.


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