25% of the FOMC Want to See a Size Cap, Also that Basel Thing

This is fascinating. Shahien Nasiripour has been asking regional Federal Reserve Bank chiefs who aren’t based in New York as whether or not there should be a size cap. And he’s found three. That sounds like only a handful, until you realize that is 25% of the 12 regional Fed presidents. 25%!

Here are some quotes:

“I have a lot of sympathy for what they’re saying,” Bullard said. “I do kind of agree that ‘too big to fail’ is ‘too big to exist’. The only thing that’s making me hesitate about that are the details about how you would split up firms [and] why would you make them split up one way as opposed to another way.

“I haven’t seen a lot on that, but I’m very sympathetic,” he said. “But the devil’s in the details about how you would actually break them up.”…

“I think they should be broken up,” Hoenig said in a March interview with the Huffington Post. “I think there’s no reason why as we’ve done in other instances of [sic] finding the right mechanism to break them into their components.”

“And in doing so, I think you’ll make the financial system itself more stable. I think you will make it more competitive, and I think you will have long-run benefits over our current system, [which] mixes it and therefore leads to bailouts when crises occur,” Hoenig said.

Fisher said that “based on my experience at the Fed… the marginal costs of TBTF financial institutions easily dwarf their purported social and macroeconomic benefits. The risk posed by coddling TBTF banks is simply too great.

There is in fact an amendment that does this that could be voted into the Senate Bill, and that is the Brown Amendment. Federal Reserve chiefs aren’t (shouldn’t?) be in the business of electioneering for this or that piece of legislation, but the fact that many are signaling that additional measures to break up the banks are needed in addition to resolution authority and Basel III should be telling us something.

Imagine

I mentioned before that we may see the financial sector of 2007 as the new normal in banking. I see that in the debate over Basel III. Check this out:

Regulatory experts who work with banks say the industry as a whole is united in its concerns about the liquidity proposals, which for the first time ever would set global requirements for the amount of liquid assets each bank and its subsidiaries have to have on hand.

The liquidity proposals come in two parts: one, known as the Bear Stearns rule, requires banks to have enough liquid assets on hand to survive a 30-day crisis, while the other, nicknamed the Northern Rock rule, requires banks to have stable long-term funding, favouring deposits and heavily disfavouring wholesale sources. It is the latter rule that has attracted most criticism. “It is an attempt to micro-manage banks’ asset portfolios,” complains one regulatory expert.

Many of the responses also focus on how the Basel proposals might interact with other responses to the banking crisis, such as a possible global levy on balance sheets, co-ordinated pre-planning for banks’ own collapses, and suggestions that global banks’ subsidiaries should be self-sufficient in every country.

If banks are fighting tooth and nail against simple liquidity proposals – essential to regulating the shadow banking system – that’s trouble. And they are. These two rules, the Bear Stearns rule and the Northern Rock rule, would go some way towards ending the arbitrage that the shadow banks were able to participate in. And those are quite simple requirements – be able to survive 30-days. Use less repo when you can use wholesale deposits. But that would cut into the profitability of the business model…

(Reading the fight over those simple requirements makes me think that some of the moderate yet incredibly reasonable suggestions to regulate the shadow banking sector I helped propose at Make Market Be Markets are about as practical as a John Lennon song: “Imagine assuming sub-AAA unsecured markets are shut for 12 months….it’s easy if you try…imagine capitalizing with the assumption of no sales of structured credit without a 40% haircut for 6 months….I wonder if you can….”)

This is the kind of stuff that keeps me worried, in case you wonder. A hard 15:1 leverage cap would at least provide a fence which the damage might help be contained.

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2 Responses to 25% of the FOMC Want to See a Size Cap, Also that Basel Thing

  1. Seth Ackerman says:

    How would a Northern Rock rule actually work? How can you make firms rely on deposits when many of them have never taken deposits in large amounts?

    Just as a thought experiment, what do you think about a much more radical proposal:
    Suppose that repo was somehow banned. Now, if a money-market fund has spare cash it wants to park somewhere, it is not permitted to lend it to a broker-dealer firm in exchange for a pledge of securities as collateral; it has to put the money in a conventional bank account. As a further thought experiment, let’s imagine that deposit insurance rules have been changed so that this large bank deposit is now fully insured by the FDIC.

    What about the broker-dealer firm that wants to borrow money to enlarge its balance sheet? It can no longer borrow directly from the money-market fund. If it wants to borrow, it must seek to open a line of credit with the bank where the money-market fund has deposited its cash. So what was once an independent network of bilateral interfirm lending (i.e., repo) has now been *intermediated* through the conventional banking system. We might also posit that the banks’ new privilege of hosting large, insured institutional deposits can be embedded in a special regulatory regime limited to a small number of big banks subject to close regulation.

    The upshot of all this is that it would no longer be possible (or, at least, likely) for there to be a run on the liabilities of broker-dealers, since their key liabilities now take the form of loans from regulated banks that are themselves funded by stable, insured deposits.

    What would the banks’ reaction be to that?

  2. engineer27 says:

    Shall we suggest other John Lennon/Beatles songs that seem appropriate?

    “I Should have Known Better”

    “Yesterday”

    “Run for your Life”

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