Thomas Hoenig, president of the Kansas City Fed and one of the most incisive critics of the “too big to fail” policy, has an op-ed in today’s NYT about the current financial reform bill before Congress. He says it does far too little to end “too big to fail” — while it sets up a mechanism for big failing financial institutions to be put under FDIC receivership, those financial institutions would still have the political clout to snag a bailout instead.
This may be true, but it seems to be a drawback in any financial reform bill that doesn’t call for the biggest financial institutions to be broken up into smaller ones that are not too big to fail, i.e., which can go bankrupt without significant systemic risk to the economy. Koenig has spoken elsewhere on the need to break up the biggest banks. It’s a position that finds favor among many liberal economists,including James Kwak of the Baseline Scenario (see previous link). Rep. Paul Kanjorski of Scranton, PA has proposed an amendment to give the government power to preemptively break up any financial institution whose failure would impose giant costs on the U.S. economy, but the Senate Banking Committee apparently has nothing like that on the table yet. Alas, the political clout of the big banks may well be enough to make bank size restrictions a non-starter in the Senate. Simon Johnson of The Baseline Scenario says much the same thing here.
Hoenig says that another provision of the bill actually makes things worse by narrowing the Fed’s supervisory role to just the nation’s 12 largest banks, most of which are headquartered in NYC. I do not know what the logic of this provision is, and Hoenig doesn’t say; maybe the idea is for the other banks to be supervised by the FDIC and/or other agencies instead. Whatever it is, Hoenig thinks the Fed needs to give just as much attention to the other 6,700 as to the top 12. As he points out, that would seem to be the whole point of having 11 regional Fed banks besides the one in New York.
UPDATE: Simon Johnson puts it a lot more plainly right here. For the record, Paul Krugman has his doubts that breaking up the banks would help much — see the last three paragraphs of this recent column. I’m with Simon Johnson here. By all means, crack down on fraudulent finance at institutions large and small, but I don’t see how you limit the power of the big banks without limiting their size, too.