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Fed’s Lacker Says Living Wills Best Hope Against Bailouts

Federal Reserve Bank of Richmond President Jeffrey Lacker said broker-dealer units of banks should have higher capital requirements than deposit-funded subsidiaries because the financial crisis demonstrated the risks that stem from a reliance on markets for financing.

Larger capital buffers have “great advantages,” Lacker said today in response to a question after a speech to the Council on Foreign Relations in New York.

“I do favor increasing capital,” Lacker said. “Broker dealers are an issue of very special concern just because of historically the way they have funded themselves and because of some other sort of special aspects of their legal status, and I think they deserve special attention especially given what we’ve just been through and the role they played in 2008.”

Lacker joins Boston Fed President Eric Rosengren in calling for lenders to hold more capital if they own a broker as central bank officials and U.S. lawmakers plan ways to prevent another taxpayer bailout of one of the biggest banks.

Rosengren said last month banks with broker-dealer units should hold more capital because such businesses pose greater risks during periods of financial duress.

Living Wills

Lacker said in his speech today that the best way to avoid more taxpayer-funded rescues of failing banks is with “living wills” that outline how troubled institutions might be unwound.

Resolution plans are the “only approach I can envision” to solving too-big-to-fail, Lacker said in his speech, which was abridged from comments he first delivered on April 9.

The effort to have large bank holding companies submit such plans “will require more hard work and detailed analysis,” Lacker said. “But I see no other way to reliably identify exactly what changes are needed in the structure and operations of financial institutions to end ‘too big to fail.’”

The 2010 Dodd-Frank Act required lenders to plan how they would be wound down if they fail. The Fed said in March that 17 of the 18 largest banks could survive a deep recession while maintaining enough capital to meet regulatory requirements.

Regulators seeking to reduce the chances of another government rescue have required banks to retain some earnings and reinforce their buffers against possible losses. New international and domestic banking rules are also guiding banks toward stronger capitalization.

Persistent Risk

Still, the risk of bank failures will always be present, underscoring the necessity of writing living wills, Lacker said in response to a question after delivering his speech.

“We’re unlikely to get to a situation where our capital buffers are so large that the probability of eating through them is driven to absolutely positively zero,” Lacker said. “You need to have a plan for what happens when the capital is gone.”

U.S. stocks are near a record, pushed higher by bank shares.

The Standard & Poor’s 500 Index fell 0.1 percent to 1,630.98 at 1 p.m. in New York after increasing 0.4 percent yesterday to 1,632.69, a fifth-straight all-time high. Financial firms are up 29 percent in the past year for the second-best gain among 10 industry groups. All but three of 82 companies in the S&P 500 Financials Index have advanced over the past 12 months.

Brown-Vitter Bill

Senators Sherrod Brown, an Ohio Democrat, and Republican David Vitter of Louisiana announced legislation last month that would impose a 15 percent capital requirement for the largest banks, saying that Dodd-Frank doesn’t prevent future bailouts.

The bill faces opposition. Senate Banking Committee Chairman Tim Johnson, a South Dakota Democrat, has said regulators should finish work on Dodd-Frank before evaluating whether it solves too-big-to-fail.

The panel’s top Republican, Idaho’s Mike Crapo, has said setting capital is a job for regulators not Congress. And House Financial Services Committee Chairman Jeb Hensarling, a Texas Republican, has said he favors bankruptcy reform over downsizing the largest lenders.

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