Thursday, December 2, 2010

Response to "Too Big to Succeed"

In today's NY Times, Thomas Hoenig, the President of the Federal Reserve of Kansas City, published an opinion piece titled "Too Big to Succeed".  He argued for reducing the size of the nation's largest financial institutions and that "to do this will require real political will."

Allow me to make a modest proposal.  The Fed should take the first step at its next Board meeting.

In its position as the regulator for these large financial institutions, the Federal Reserve has significant powers.  One of these powers is the ability to require these financial institutions to disclose information. The Fed should use this power and require that these financial institutions disclose to all market participants on a current basis all credit exposures.  This would include everything in these institutions' investment, loan and derivative books.

At a minimum, as Mr. Hoenig stated, "those who control the largest banks will argue that such action would undermine financial firms’ ability to compete globally."  Hopefully, he and his fellow members of the Board will not be persuaded by that argument.

Personally, I think the large financial institutions will fall back on three of their favorite arguments:

  1. It would cost too much.  Relative to the trillions of dollars the financial crisis has cost, the 5 basis points (0.05 percent) cost of providing this data to all market participants is insignificant.
  2. It would overwhelm investors with data.  Actually, they too are also investors and they most certainly have the ability to process the data to see what is going on.
  3. It would reduce the amount of credit available.  It would only reduce the amount of credit offered to firms and individuals where the loan exceeds the ability of the firms and individuals to repay.  Financial institutions that make these types of loans can expect to see their access to capital reduced and the cost of this capital increase.

What disclosing this data will do is limit the ability of these firms to take risk.  It will bring back market discipline as investors can see what is going on with these firms.

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