Dallas Fed's Fisher and Rosenblum examine how to shrink Too Big to Fail and find transparency

In their Wall Street Journal column, the Dallas Fed's Richard Fisher and Harvey Rosenblum examine why the Dodd-Frank Act does not end Too Big to Fail and they offer a proposal they think will succeed in ending TBTF.

Regular readers know that your humble blogger prefers to end the TBTF banks by requiring them to provide ultra transparency rather than rely on a solution that assumes policymakers and regulators will not bail these banks out in the future.

Ultra transparency ends TBTF because it makes the unsecured bank bond and equity investors responsible for the losses on their investment.  Investors become responsible for the losses because they have access to the information they need to independently assess the risk of an investment in the banks.

Currently, investors are protected from losses on their investment in the banks for two reasons.

First, they do not have access to the information they need to make a fully informed investment decision.  Banks are 'black boxes'.

Second, in the absence of the needed information, investors are relying on the government' investment recommendation.  This recommendation creates a moral obligation to bailout the banks and protect the investors from solvency related losses.  This investment recommendation is renewed every year through the stress tests and the subsequent statements about bank solvency.

[T]he mere 0.2% of banks deemed "too big to fail" are treated differently from the other 99.8%, and differently from other businesses. Implicit government policy has made these institutions exempt from the normal processes of bankruptcy and creative destruction. 

Without fear of failure, these banks and their counterparties can take excessive risks. 

It also emboldens a sense of immunity from the law. As Attorney General Eric Holder admitted to the Senate on March 6, when banks are considered too big to fail it is "difficult to prosecute them . . . if we do bring a criminal charge, it will have a negative impact on the national economy."... 

This is patently unfair. It makes for an uneven playing field, tilted to the advantage of Wall Street against Main Street, and it places the financial system and the economy in constant jeopardy. It also undermines citizens' faith in the rule of law and representative democracy.

This uneven playing field is the result of the policy of financial failure containment and its corollary, the Geithner Doctrine.

Under this policy, the Japanese Model for handling a bank solvency led financial crisis was adopted and bank book capital levels and banker bonuses were protected at all costs.

These costs include undermining citizens' faith in the rule of law and representative democracy (please note that this is not restricted to the US, but also applies in the EU).

The 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act was a well-intentioned response to the problem. Its stated promise—to end "too big to fail"—rings hollow. 

With a law that runs 849 pages and more than 9,000 pages of regulations written so far to implement it, Dodd-Frank is long on process and complexity but short on results. 

Regulators cannot enforce rules that aren't easily understood.

Please re-read the highlighted text as Mr. Fisher and Mr. Rosenblum have nicely summarized why the combination of complex rules and regulatory oversight fails and why the financial system should not be dependent on this combination working for ongoing financial stability.

Further, market discipline is still lacking for the largest dozen or so institutions, as it was during the last financial crisis. 

Why should a prospective purchaser of bank debt practice due diligence if in the end, regardless of new layers of regulation and oversight, the issuing institution won't be allowed to fail? 

The return of marketplace discipline and effective due diligence of banking behemoths is long overdue....

Please re-read the highlighted text as Mr. Fisher and Mr. Rosenblum make the case for requiring banks to provide ultra transparency and disclose on an ongoing basis their current global asset, liability and off-balance sheet exposure details.

Without this data, a prospective purchaser of bank debt cannot perform due diligence.

Without due diligence, there is no market discipline on the banks.

The only way to bring about the long overdue return of marketplace discipline and effective due diligence of banking behemoths is to require ultra transparency.

Your humble blogger liked how Mr. Fisher and Mr. Rosenblum described the benefits of addressing TBTF.  As a result, I have taken the liberty to replace their expression "this plan" with ultra transparency.

Had ultra transparency been in place a decade ago, it would have altered the insidious behaviors that contributed to the crisis, avoiding the bailouts and their aftermath, the cost of which our nation's citizens will bear for years to come. 

The Government Accountability Office and others estimate the cost of the financial crisis, measured in lost output and jobs, to be between $10 trillion and $20 trillion, roughly one year of U.S. output down the drain.

It is simply stunning to look at ultra transparency from a cost/benefit analysis perspective.

The cost of the banks providing ultra transparency is less than $10 billion globally per year.  The benefit is saving $10 - $20 trillion.  This is at least a 100 fold return on investment.

Most of all, adoption of ultra transparency would have avoided a crisis that undermined Americans' belief in the fairness and justice of the economic system. 

The United States was founded on the principle of economic freedom, underpinned by secure property rights and by a strong aversion to special favors and subsidies to the few. 

Those fundamental virtues were undermined by the recent financial crisis and government's response to it. 

Rescuing too-big-to-fail banks from their bad investment decisions imposed an enormous economic burden on the American people. It also perpetuated a sense that powerful banking mandarins operate above the law and prosper at the expense of the thrifty and hardworking citizenry. 

Congress should rewrite Dodd-Frank so that it actually ends the problem of banks that are too big to fail. Our proposal [ultra transparency] won't lead to bigger government. It will lead to smaller banks governed by the market discipline of creditors who are at real risk of losses, and by laws that apply equally to all.