Dallas Fed’s Fisher Criticizes Dodd Frank as Not Going Far Enough on TBTF

Ordinarily, pointing out that long-standing critic of too big to fail banks is still unhappy about them would not count as news. But the commentary of Dick Fisher, the head of the Dallas Fed, and that of his research director, executive vice president Harvey Rosneblum, is noteworthy because it stands in contrast to the emerging conventional wisdom inside the Beltway. I was told last week that the prevailing and accurate view of last year, that Dodd Frank didn’t go far enough, is being supplanted by the Jamie Dimon view that’s it’s too intrusive. Note that those aren’t actually inconsistent: effective bank regulation IS intrusive. Banker unhappiness would ordinarily be a good sign, but the crisis perps have taken to howling at any intrusion on their imperial right to profit. And the worst is that third parties take their kvetching seriously.

it’s also worth noting that Fisher is decidedly right wing. He thinks the Fed should be more transparent, opposed QE too, and thinks that uncertainty over regulation is deterring business investment (note that this actually shows up as #4 or lower as an issue in most surveys).

What is striking is the way the Dallas Fed annual report puts the TBTF issue as the biggest impediment to a return to prosperity. That’s consistent with an IMF study of 124 financial crises, which found that getting tough with banks and forcing them to recognize their losses (which in the US would have resulted in the radical restructuring of at least Citigroup and Bank of America) produced a deep but short fall in growth and a strong rebound. By contrast, our recovery is barely worthy of the name.

Fisher’s letter in the just-released Dallas Fed annual report describes the concentration in the US banking industry, with the 10 biggest banks holding 61% of industry assets versus 26% two decades ago. And even though Fisher makes a dig over “uncertainty” in fiscal policy, he points out that the real problem is that bank balance sheets are weaker than the banks or the recent stress tests would have you believe:

But to borrow an analogy Rosenblum crafted, if there is sludge on the crankshaft—in the form of losses and bad loans on the balance sheets of the TBTF banks—then the bank-capital linkage that greases the engine of monetary policy does not function properly to drive the real economy. No amount of liquidity provided by the Federal Reserve can change this.

Rosenblum makes a Minskian argument, that the protracted Great Moderation produced too much complacency, although he has a bit more Darwinian tooth and claw in his account than most NC readers will take well. He calls for higher capital levels at the biggest banks and argues they should reduce dividends. He also doubts that Dodd Frank resolutions will work:

Will the new resolution procedures be adequate in a major financial crisis? Big banks often follow parallel business strategies and hold similar assets. In hard times, odds are that several big financial institutions will get into trouble at the same time.14 Liquid assets are a lot less liquid if these institutions try to sell them at the same time. A nightmare scenario of several big banks requiring attention might still overwhelm even the most far-reaching regulatory scheme. In all likelihood, TBTF could again become TMTF—too many to fail, as happened in 2008.

A second important issue is credibility. Going into the financial crisis, markets assumed there was government backing for Fannie Mae and Freddie Mac bonds despite a lack of explicit guarantees. When push came to shove, Washington rode to the rescue. Similarly, no specific mandate existed for the extraordinary governmental assistance provided to Bear Stearns, AIG, Citigroup and Bank of America in the midst of the financial crisis.15 Lehman Brothers didn’t get government help, but many of the big institutions exposed to Lehman did.16
Words on paper only go so far. What matters more is whether bankers and their creditors actually believe Dodd–Frank puts the government out of the financial bailout business. If so, both groups will practice more prudent behavior…

The pretense of toughness on TBTF sounds the right note for the aftermath of the financial crisis. But it doesn’t give the watchdog FSOC and the Treasury secretary the foresight and the backbone to end TBTF by closing and liquidating a large financial institution in a manner consistent with Chapter 7 of the U.S. Bankruptcy Code (see Box 1). The credibility of Dodd–Frank’s disavowal of TBTF will remain in question until a big financial institution actually fails and the wreckage is quickly removed so the economy doesn’t slow to a halt. Nothing would do more to change the risky behav- ior of the industry and its creditors.

The problem is, as we’ve written earlier, is that all the TBTF banks have large trading operations that are tightly coupled via counterparty exposures to other major players. And there is no way to liquidate a trading book tidily.You have to stop the music and value complex positions. No coutnerparty wants to suffer by having positions frozen and assets tied up, so they’ll exit as soon as they sense serious trouble. That’s why Bear went down in less than two weeks. Runs on dealers happen quickly. The best you can do is a Bear-type process, of moving the trading operations into a stronger firm, and that only makes the concentration issue worse. That’s why breaking up TBTF banks isn’t sufficient. You need to reduce the tight coupling, by eliminating or severely restricting the use of the products that are big contributors to the interconnectedness. Credit default swaps top our list.

It’s striking that memories of the crisis have apparently faded enough that the Dallas Fed found it necessary to provide a history. You’d think the specter of high unemployment and millions of underwater homeowners would be a reminder. It serves as a reminder of how insulated people in policy circles are from the realities afflicting ordinary Americans.

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  1. War Fed

    ‘the emerging conventional wisdom inside the Beltway.’
    Oh the thrill of the English language, ‘here’s an oxymoron there’s an oxymoron, let’s tear the whole thing down.’

  2. Nowhuffo

    Nothing has changed. There was a time when this country could see problems and react to solve them. While this is not democracy’s strong suite I see no chance of this with the partisanship in Congress and the selfishness on Wall Street. Consequently the TBTF will eventually end and it will end badly. Apparently it will take one more crisis (and it will be a beaut)before we run out of excuses to fix that which is broken.

    1. Darren Kenworthy

      The inability to perceive and effectively respond to problems is symptomatic of a lack, not an excess, of democracy.

      1. jonboinAR

        I cannot stop thinking that it’s a result of a large majority of the American population choosing to not pay any attention except to a few brief attack commercials right before election day. You may say I’m blaming the victim, but the victim continues to stand there right in the line of fire, or return to the three-card monte table, or whatever analogy you want to use.

  3. Johnny Clamboat

    “it’s also worth noting that Fisher is decidedly right wing. He thinks the Fed should be more transparent, opposed QE too, and thinks that uncertainty over regulation is deterring business investment”

    Are those right-wing positions? Certainly the last one is held by many right-wingers but holding it doesn’t make one a winger.

    1. C

      I would say that they are at present if only because of the assumption that everything the DNC favors is “left wing” and everything the RNC favors is “right wing” and at the moment, with a Dem in the White House only the “right wingers” are fighting for government transparency.

      Well, right wingers and those wacky nobodies who stand on principle and are thus kept well out of the beltway. Nothing spoils a good chummy club meeting like people who care about principles more than team spirit.

      1. Johnny Clamboat

        True enough. My understanding would have been aided had I broken out my tribalist hack decoder ring. Unfortunately brandishing that ring turns one into a drooling cretin like most of Teams Red and Blue.

    2. nonclassical

      ..there are two political-economic views allowed by corporate media-

      1) Austerity
      2) Stimulus

      ..austerity includes several “histories” of economic destruction-to the degree this history goes unknown or ignored, it has advocates.

      ..stimulus is Q.E…for one..and bushbama’s apparent hope to kick the can down the road..

      Meanwhile, ignored for partisan political-media false debate of austerity-stimulus, is ACCOUNTABILITY…of the triumvirate, “transparency, oversight, accountability”…which are linked-needed as such…

    3. Glen

      I think it’s safe to say that the majority of Americans were opposed to the bailout.

      Now for a little clarity, it’s also safe to say that the majority of Americans did not want a calamity which resulted in another great depression. The real debate should have been over what exact corrective actions should be taken. What we ended up getting was robbed when a gun was stuck to our heads and our tax dollars were looted – little to no reform, no criminal actions, and no relief for average Americans.

    1. F. Beard

      Quite shocking, considering it’s coming from the Dallas Fed! Economic Maverick

      Not really. There’s always a Fed official or two to play “good cop” or the “voice of reason”. Many people applauded that Fed guy who said it was the Fed’s job to take away the punch bowl just when the party got started. My reaction was the opposite; I thought the punch bowl should be smashed.

      The Fed should have no business boosting or dampening the economy like they own it which they essentially do.

  4. F. Beard

    Banker unhappiness would ordinarily be a good sign, but the crisis perps have taken to howling at any intrusion on their imperial right to profit. Yves Smith

    Make that imperial privilege to profit.

    Banking should be an entirely private business but it isn’t so we live in a fascist country.

  5. Jackrabbit

    Well if we can’t put the transgressors in jail, and we can’t regulate them, at least we know that to our culture values will keep the corporations in check as they fear the shame that . . .


  6. steelhead23

    What I find disconcerting is the assumption that the system must not be allowed to fail badly. That is, fail in a domino fashion, severely limiting or even halting credit flow for some period of time. Now, I am not so foolish as to not recognize that such an event would harm individuals and institutions, including governments. But, it is this tendency to view such an outcome as simply “unthinkable” that debilitates those in a position to make decisions. We are smart. We really could think through how we would respond in such a crisis. In fact, we must. Indeed, I would suggest to NC and academia that they do just that – consider the effects of a broad TBTF collapse on global credit markets and create a rational scheme to minimize the duration of such a crisis. My view is that it is the meme of TBTF that results in a lack of prosecutions for fraud, the capitulation of government to finance, settlements that stink, etc. etc. Thus, we should see TBTF as an ideological enemy and set out, carefully and thoughtfully, to destroy it.

    This benefits decision makers in two ways. The first obviously is that with such a plan in hand TPTB would have a comeback to the TBTF CEOs of “you need us.” No we don’t. Second, some have suggested that even with central bank backstopping, a systemic failure remains not only possible, but likely, perhaps even inevitable. Thus, if a TBTF failure cascade is even a remote possibility, society would gain from an understanding of its ramifications and possible solutions. As a reader of George Lakoff, I am wondering if it would make sense for the more enlightened bloggers to simply discontinue using the phrase “too big to fail” in favor of something more descriptive – Global Banking Cartel, which seems to better fit their criminogenic nature.

    1. Pepe Savings and Loan

      Yes, we’re talkin about criminals here, use the words Capital One, or Chase, etc if it’s helpful instead of TBTF. The appropriate, and general use of TBTF already means “evil” or “the cause of it all” to most ‘Muricans. I give you a common example: “That TBTF Criminal enterprise stole my Mother’s house”

    2. Lyle

      If you read books about Feb, March 1933 you see the effects of a fall of dominos in the financial system. State by state you had bank holidays being declared, after currency was withdrawn from the banks and put in mattresses, as well gold being withdrawn. In that case for example you probably could not break a $100 bill as no one would have change, and obviously the ATM and Credit card networks would go down hard. Then the question might be how much in 20s would you have around the house to live on. Of course you could do as was done at that time when some entities issued scrip.
      The question is would people stand for the kind of conditions that held in late feb early march 1933, or would there be riots in the streets?

  7. Glen

    You need to reduce the tight coupling, by eliminating or severely restricting the use of the products that are big contributors to the interconnectedness. Credit default swaps top our list.

    CDSs are completely unregulated, so it would it seem the only way to “break up” the CDS market is let them fail. Watching Timmy bail out AIGSs CDSs was one of those times when you suddenly realize common sense was not going to prevail.

    1. Yves Smith Post author

      So regulate CDS. This isn’t that hard. Equites were unregulated too, once, remember?

      The issue is political will, not feasibility .

      1. Mark P.

        No, it is very hard. As you know, the issue is political will and the money that buys everyone. I’m sure you don’t think of yourself as in any way a naive person — and you’re not, by normal standards. But you still underrate the mercilessness of the system’s attacks on someone in the system who suddenly gets an attack of ethics and then tries to do the right thing. Anyone of consequence who breaks ranks is quickly marginalized, often has their career destroyed, and is frequently personally broken by seeing everyone they’ve personally trusted join the ranks of those working to destroy them.

        I have watched such situations and seen persons of consequence broken in that way. It was an education about the human race.

        You have to be an individual like Daniel Ellsberg — who was, remember, a strategist working on the same levels as Kissinger and Tom Schelling, his mentor — to get away with it. Ellsberg knew he would have to give everything up, knew he would only get one move and planned over a long time to execute his one move successfully.

        1. Nathanael

          We have to make sure that the criminals who do the wrong thing suffer equally great penalties.

          Heck, people are working on it with Rush Limbaugh, and it will probably work.

          I would point out that the mentality I describe — they were unrelenting in destroying us, so we must be more unrelenting in destroying them — is exactly the mentality which once the French Revolution started, and once the Russian Revolution started. And it *works*.

          It is the *only possible response* to kleptocrats, so practically everyone will be agreeing with it sooner or later. If it’s sooner, we may get the kleptocrats out fairly peacefully. If it’s later, with the kleptocrats even more powerful, it will happen through their actual deaths. Thus, let’s do it sooner, please.

      2. Ms G

        “Equities were unregulated too, once.”

        Whatever appearance of equities regulation we have had in place has not done much to protect millions of Americans who have seen their savings or investments trashed . . . granted, you also have to factor in the the legallly tolerated worker/saver skimming-scheme that are mutual funds, pensions, etc.

        For large swaths of the 99% equities in the past 20 years have proven to be a a risk-filled return-free experience running parallel to a very risk-free high-return fee-fest for the financiers “managing” those equities via all sorts of predatory “business models.”

        Not to suggest that CDS and derivatives shouldn’t be regulated. Just that whatever regulation is proposed shouldn’t be taking too many pages from the regulation concepts (simulacra?) that have officially protected equities investors.

        1. Yves Smith Post author

          This is counterfactual. The equity markets have good disclosure, access to real time pricing, tough rules on order execution, and prohibitions against front running customer orders and insider trading that are well enforced.

          You need to read Benoit Mandelbrot’s The (Mis)Behavior of Markets. Standard financial theories understate risk, with the result that investors, particularly retail investors, allocate too much to equities. In general, the public is told to expect returns that cannot readily be attained without excessive risk assumption.

          The problem is models and conventional wisdom, not the regulation of the equity markets.

          1. Ms G

            Except that the benefits of the regulatory devices you describe can, and are, neutralized by the reality and mechanics of conflicted money managers. Take 401(k) plans, bank trust accounts, or pension monies invested in mutual funds, for instance — frequently loaded up with actively manged a (high fee) and proprietary (high fee and crap)fees — massive drains on whatever real returns on the presumably well-regulated equities, and that’s not even counting the kickback schemes between ERISA plan sponsors or bank fiduciaries and the money management firms that persuade them to invest in lousy “products” (funds). Millions of small retail account holders (deferred comp, small investment account at a bank) in reality have no ability to act on any of the information provided by the regulations because they are reliant on money managers/trustees/fiduciaries who have been revealed to be every bit as conflicted and predatory as the actors in the mortgage, securities, CDS space. Only difference is that with respect to that particular scr**ed constituency, the President and his Regulators have just pretended it doesn’t exist — not even Potemkin “rescue” schemes have been put forth to make-whole or compensate those losers.

            Imagine how much liquidity could have been generated in the aftermath of the Crash if Obama, Treasury and the Fed had created a “TALF” or a “TARP” to put-back cash dollars that disappeared from savers/pensioners’ accounts as a result of the mortgage-CDO-CDS cancers . . . which, after all, did not just crash the mortgage market and its related “products” but also the equities markets.

            I will definitely follow up on your reading recommendation. However, it is also true that at the “retail” level where mutual funds have become the primary way that working people invest in equities, transparency, execution rules, etc., do not produce honest returns.

          2. Glen

            Thanks for the reply.

            I was hoping that the failure of the unregulated market would be a driver to establish a regulated market or at least to start calling CDSs insurance and lump them under existing regulation. Right now, there’s no impetus to make the transition, nor any provisions in Dodd-Frank (of which I am aware).

            Instead Geithner’s action legitimized the current status quo.

          3. Nathanael

            Yves, one of the problems is that the bond markets — the supposedly “safe” investments — have at least as much risk as equities, less transparency, higher transaction costs, less honesty, etc. etc.

  8. Phil Perspective

    It serves as a reminder of how insulated people in policy circles are from the realities afflicting ordinary Americans.

    Truer words were never spoken. It’s why people like Matt Yglesias and Ezra Klein are jokes, not to mention any Republican.

  9. r stolte

    Today’s unanimous SCOTUS decision favoring the Sacketts over the overreaching EPA may be the answer to end the foreclosure criminality of the banksters and their government enablers. The Sackett case was about property rights and due process, both of which are being denied to so many homeowners in foreclosure. Since the “settlement” will just allow these predatory acts to continue, a favorable SCOTUS ruling may be the only possible relief. I’m not an attorney, but should the federal court that’s reviewing the “settlement” approve it, could that decision then be taken up to the SCOTUS? Thoughts anyone?

      1. Nathanael

        The Sackett case is funny. They won the right… to have a court hearing.

        At the court hearing, of course, they’ll lose on the merits, because it looks like they don’t have a leg to stand on.

        But it is absolutely true that they have a right to a court hearing, which is why this is a 9-0 decision.

  10. Pitchfork

    In one of the last SigTARP reports, Geithner admits that even under the Dodd-Frank “resolution authority” regime there would still be bailouts in a crisis:

    “As Secretary Geithner told SIGTARP, while the Dodd-Frank Act gives the Government ‘better tools,’ and reduced the risk of failures, ‘[i]n the future we may have to do exceptional things again’ if the shock to the financial system is sufficiently large.”


    1. bmeisen

      wonderful link! Covert nationalization didn’t work. Would overt nationalization, a la Sweden 1994, work? Is the CDS issue that Yves highlights relevant? i.e. nationalization of single banks would not work because of the interconnections?

  11. PeakVT

    And there is no way to liquidate a trading book tidily.You have to stop the music and value complex positions.

    Why is it necessary to break up TBTF operations overnight?

    They way to go about this is for the FDIC or some other organization to levy fees on banks that not only reflect the risks on their balance sheets but also the risks they present to the economy. TBTF institutions will figure out a way to break themselves up neatly once the “externalities” (for lack of a better word) of their size is captured from their cashflow.

    Of course, there is a chicken/egg-type problem in getting a better fee structure implemented…

  12. Fiver

    Agree in part with Steelhead 23 above re the terror value of TBTF.

    Accepting THIS and therefore the guaranteed global debacle this path entails, out of fear of imagined, but nonetheless CERTAIN chaos, a fear so certain even the possibility of a thoughtful, deliberate, planned, and transparent disruption of markets – say a bank holiday – in order to decisively DEAL with the problem, is everywhere deemed Beyond The Pale. Out of the question. Hopelessly naive. Even “mad”.

    I however have no doubt at all that the expertise, power, and authority existed to roll up the bunch of them the first time around, sorting it all out calmly, consistently, fairly etc. while keeping things running OK even for months if that’s what it took. Hard to win if the goal is defined on all sides as impossible, as if the system was in fact booby-trapped and rigged to explode should anyone try to disarm it.

    Well phooey to that. If the President of the United States can re-order the entire economic and social fabric of the country for reasons of “war” or other “emergency” he can quite obviously ensure he has all he needs to deal with this smallish network of elite criminals (a few thousand all told) – like sending them an invite to talk about their prospects if they don’t get onside of a full-scale, very thorough and deep cleaning up immediately.

    However, what we have here is neither a principled President nor Fed – just the reverse, really – so it wouldn’t surprise me one bit if BoA or Citi is finally allowed to “blow up” (greeted as a complete “surprise” in MSM, even the business portions) and “resolved” just to demonstrate to “Markets” those wonderful guys at the Fed DO have control of the “system” again, thus finally, fully launching a bubble in good ole American “confidence”.

  13. ignim Bites

    Can anyone imagine that Geithner could get the blank check from Congress that Paulson was able to wrangle? So if there is to be a bailout in the next round of the GFC it will come from the FED probably in the form pioneered by Draghi. But the more dreck central banks take on to their balance sheets the less effective the can be in controlling money supply via open market operations. This is the gateway to high inflation.

    1. Faux Snooze

      The unemployed experience what is called Depression, sometimes in more than one way. But never mind misery, crumbling infrastructure, and what have you. The concern for inflation seems to come more readily from the blowholes embracing the criminogenics of the Banksters. Isn’t the “gateway” to a housing recovery (according to the owner/ruler class) is to have home prices inflate? Save the rich?

      1. Ms G

        It sure seems that way. All the remedial efforts seem geared to protecting credit-inflated assets (including, and especially real estate). Except, of course, in those remedial efforts involving the bank sales to vulture investors of huge masses of defaulted properties which the investors/banks will now turn around and RENT to the impoverished masses for whom the artificially inflated assets are, of course, out of any reach (even with 3% mortgages).

        It’s really so simple and horrible.

  14. Susan the other

    If it is a CDS problem, they should do as one reader said here a few months ago: Take these contracts to a judge and have them declared to be null. It’s either something like that, dealing with contracts in a judicial setting, or set up a system that untangles the mess by canceling out equally weighted obligations between parties. When they get to the end of that mess you’d think it would be the same result as canceling the contracts judicially. It will just take a lot more calculus. And we all know that if no authority has the fortitude to do either of the above, the taxpayer will pay the stupid things off with treasuries.

    1. Nathanael

      CDS are unregulated insurance contracts.

      They’re *illegal under common law*.

      They’re *illegal under the law of every single state*.

      This is because they *do not require insurable interest* and they *do not require that the issuer has capital*.

      There’s a reason for this: history showed that unregulated insurance of this sort was a disaster.

      They were specifically legalized by Phil Gramm’s “Commodity Futures Modernization Act”, for which he is a traitor to the United States (I really do think so, as there is no better way to give aid and comfort to our enemies than to wreck the economy by legalizing a well-known danger).

      I really think there must be some means by which that law, overturning the laws of 50 states and hundreds of years of common law for the purpose of relegalizing a known source of fraud and economic collapse, could be found unconstitutional. It was certainly against public policy.

  15. Schofield

    We should consider at least two things when it comes to the banking function.

    Firstly, private banks aren’t even private enterprises they are Public/Private organisations. Without government’s Lender of Last Resort and Deposit Insurance support they would struggle to stay in business if the 2008 Credit Crisis is anything to go by where the Invisible Hand was disgracefully and incompetently turned into the Invidious Hand. Of course, these Public/Private organisations actually need “privatizing” but not in a way the Banksters would care for. Hypocritically we also know for sure this isn’t the kind of privatization the Neo-Liberals would support.

    Secondly, the Credit Crisis was made worse than it needed to be because volatile short-term deposits were being used to fund long-term assets. The first hint in the media that the Mortgage Bonds many banks still had on their books had actually been constructed on a “Cash for Trash” basis and any residual value they might have was poor encouraged a wide spread panic by the short-term depositors, hence the Credit Crisis. Morgan Ricks argues that the loan industry needs to be forced to “term out” (go long term) on “big ticket” assets.

  16. Nathanael

    “And there is no way to liquidate a trading book tidily.”

    FDR knew how to do it: bank holiday. Suddenly freeze markets and ban transactions for a week or two, and you have plenty of time to liquidate.

    You have to walk in with the big hammer and ban all contracts of the relevant sorts for two weeks though. It’s tidy, but shocking.

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