Two Important Financial Reform Catches: Resolution, and Federal Reserve Presidents on 716

Shahien Nasiripour has been on a roll this week. First he caught this really important story about the credibility of resolution authority:

The financial reform bill championed by the Obama administration and Senate Democrats as permanently ending the idea that large, interconnected financial institutions are too big to fail does no such thing, analysts at Moody’s Investors Service cautioned today in a new report.

“[A] key issue that challenges the feasibility of the proposed legislation is that it would not fully eliminate the issue of interconnectedness, nor is it likely that resolution authority could fully eliminate the systemic implications of allowing a large and/or highly interconnected firm to default, especially with respect to large international groups, and it certainly would not eliminate the risk of contagion,” the team of analysts led by Robert Young wrote.

“[T]he interconnectedness and contagion risks would not be completely eliminated, nor would the incentives and tools for regulators and the government to provide support via emergency liquidity or other programs that would continue to be part of the framework,” they noted.

Moody’s has been massively discredited as the overseers of the economy, but they do represent a baseline, generic opinion of what a market participant thinks. And they think, as it currently stands, that resolution authority isn’t that credible. Maybe the conference committee should focus on elements capable of making resolution authority more credible for the future of our financial economy.

And here’s a better catch. In move that should excite financial reformers, Federal Reserve regional chairs are coming out to support section 716 as it enters conference committee. Shahien flags letters from both Federal Reserve Bank of Kansas City President Thomas M. Hoenig and Federal Reserve Bank of Dallas President Richard W. Fisher that both say that section 716 is an appropriate thing for our financial sector. Here’s Hoenig:

Dear Senator Lincoln:

As you know, commercial banks are the trusted guardian of depositors’ funds and the primary intermediary of the national and global payments system—a role that is critical to our country’s financial and economic stability. I have been a long-time proponent of limiting the derivative activities of commercial banks to only those designed to mitigate the institution’s balance sheet risk. Accordingly, I support the reinstatement of Glass-Steagall-type laws to separate higher-risk, often more-leveraged, activities of investment banks from the commercial banking system.

Section 716 appropriately allows banks to hedge their own portfolios with swaps or to offer them to customers in combination with traditional banking products. However, it prohibits them from being a swaps broker or dealer, or conducting proprietary trading in derivatives. The risks related to these latter activities are generally inconsistent with the funding subsidy afforded institutions backed by a public safety net. Such activities should be placed in a separate entity that does not have access to government backstops. These entities should be required to place their own funds at risk.

I appreciate the opportunity to comment on this matter which is of utmost importance to our nation’s long-term financial and economic stability.


Thomas M. Hoenig

Fisher has a similar letter at the link. An interesting development.

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