The
Federal Reserve Bank of Dallas recently released its 2011 Annual Report. I'd like to focus on one part of the report, the
opening Letter from the President of the Dallas FRB, Richard W.
Fisher. Mr. Fisher is well known as a dissenting voice among Federal
Reserve Bank Presidents, a fact that will become very apparent as you read the
passages that I have selected from his single page musings.
Mr.
Fisher sets the tone in the first sentence of his letter:
“If
you are running one of the “too-big- to-fail” (TBTF) banks—alternatively known
as “systemically important financial institutions,” or SIFIs—I doubt you are
going to like what you read in this annual report essay written by Harvey
Rosenblum, the head of the Dallas Fed’s Research Department, a highly regarded
Federal Reserve veteran of 40 years and the former president of the National
Association for Business Economics.”
In
case you'd forgotten, it was these so-called indispensible banks and financial
institutions that very nearly drove the American and world economy into a
Depression. It was because of this that Congress passed the Dodd-Frank Wall Street Reform and Consumer Protection
Act. This
Federal law created the Financial Stability Oversight Council (FSOC) to prevent
such a bank-led collapse in the future by reducing America's dependence on
overly large banks that cannot be allowed to fail for fear that the economy
would implode. The Act will basically create a new banking regulatory
environment that enforces both accountability and transparency at the same time
as consumers are protected from risky actions by the banking industry. In
a nutshell, the Dodd-Frank Act is a desperate attempt to put an end to the
issues related to having financial institutions that are too big to fail for
once and for all.
While
the intentions of Dodd-Frank were good, Mr. Fisher notes that there has been an
unintended consequence of Dodd-Frank. Imagine that, an unintended
consequence of a legislative act! The Dallas FRB is concerned that
Dodd-Frank has actually increased concentration in the banking industry. For
your illumination, here is a pie chart showing how the concentration in the
U.S. banking industry has increased over the forty year period from 1970 to
2010:
In
1970, the top five banks controlled only 17 percent of the country's assets; by
2010, the top five banks controlled 52 percent of assets. In Mr. Fisher's
letter, he notes that the top 10 banks now control 61 percent of commercial
banking assets, up from only 26 percent 20 years ago. To put the size of
these assets into perspective, the assets of the top 10 banks alone are equal
to one half of the nation's GDP. On top of the concentration of assets, the
number of smaller institutions has dropped markedly from 12,500 in 1970 to
5,700 in 2010. These smaller institutions which were generally well
managed prior to and throughout the crisis, controlled 46 percent of banking
assets in 1970; this fell to a meagre 16 percent in 2010. Basically, this
data is telling us that not only have banking assets been concentrated in the
hands of fewer bigger banks but that the assets controlled by fewer smaller
banks have decreased by a disproportionately large amount.
Mr.
Fisher goes on to note:
"In
addition to remaining a lingering threat to financial stability, these
megabanks signifi- cantly hamper the Federal Reserve’s ability to properly
conduct monetary policy. They were a primary culprit in magnifying the
financial crisis, and their presence continues to play an important role in
prolonging our economic malaise.”
There
are good reasons why this recovery has remained frustratingly slow compared
with periods following previous recessions, and I believe it has very little to
do with the Federal Reserve. Since the onset of the Great Recession, we have
undertaken a number of initiatives— some orthodox, some not—to revive and
kick-start the economy. As I like to say, we’ve filled the tank with plenty of
cheap, high-octane gasoline. But as any mechanic can tell you, it takes more
than just gas to propel a car.
The
lackluster nature of the recovery is certainly the byproduct of the
debt-infused boom that preceded the Great Recession, as is the excessive
uncertainty surrounding the actions—or rather, inactions—of our fiscal authorities
in Washington. 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."
M1
has grown by $850 billion or 62 percent since the beginning of 2008 and M2 has
grown by $2.4 trillion or 32 percent. The growth in both M1 and M2 is
unprecedented in recent history and should have provided ample (some would say
way too much) liquidity. Apparently, the Fed is doing what it has done in
the past, dumping vast volumes of cheap money into the economy to prod reluctant
consumers and corporations to borrow.
As I’ve noted in previous postings, it simply has not worked this time.
So,
what's the problem? Those same TBTF banks that taxpayers bailed out still
hold a massive quantity of toxic assets related to their "sins of the
past" on their balance sheets. As well, the seemingly never-ending
collapse in the real estate market bubble has made reluctant borrowers out of
consumers and reluctant lenders out of bankers. As well, with Dodd-Frank being perpetually in limbo, banks
both large and small are uncertain about their futures.
The
issue of the TBTF banks is still problematic. The author of the
accompanying "Choosing the Road to Prosperity" report, Harvey
Rosenblum, notes that the situation in 2008 did actually cause the failure of
commercial banks holding nearly one-third of the assets in the banking system
but that extraordinary intervention by the government (read, taxpayers) kept
the banking system on life support. Dodd-Frank will prevent those actions
in the future. He notes that
the very concept of TBTF is contrary to the foundations of capitalism; it
creates an unequal playing field where certain institutions are granted the
right to make risky business decisions and ignore the risk of failure whereas
smaller institutions are forced to make what may appear to be less rewarding
business decisions simply because there is no rescue program in place since the
economy won't miss them if they should disappear. This completely removes
the freedom of businesses to both succeed and fail based on their decisions. In other words, the concept of moral
hazard.
Here's
what Mr. Fisher has to say in closing:
"The
TBTF institutions that amplified and prolonged the recent financial crisis
remain a hindrance to full economic recovery and to the very ideal of American
capitalism. It is imperative that we end TBTF. In my view, downsizing the
behemoths over time into institutions that can be prudently managed and
regulated across borders is the appropriate policy response."
With the United States government facing an almost
insurmountable debt mountain, the Federal Reserve having a massively bloated
balance sheet and the TBTF banks still carrying untold trillions of dollars
worth of toxic assets on their books, we may find out sooner rather than later
how important Mr. Fisher's advice is.
