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March 7, 2014

America’s big banks still dangerously complicated

“It is unusual for a senior government official to produce a short, clear analytical paper. It is even rarer when the official’s argument both cuts to the core of the issue and amounts to a devastating critique of the existing order.”

“In a speech delivered on February 24, Thomas M. Hoenig, vice chairman of US’s Federal Deposit Insurance Corporation (FDIC), did exactly that. These four pages are a must-read not only for economic policymakers around the world, but also for anyone who cares about where the global financial system is heading.”

“Hoenig, former President of the Federal Reserve Bank of Kansas City, has spent his career working on issues related to financial regulation. He communicates effectively to a broad audience – and understanding the technicalities of finance is not needed to grasp his main points.”

“One of those points is that the world’s largest financial firms have equity that is worth only about 4 percent of their total assets. As shareholders’ equity is the only real buffer against losses in these corporations, this means that a 4 percent decline in their assets’ value would completely wipe out their shareholders – taking the companies to the brink of insolvency.”

“In other words, this is a fragile system. Worse, the current regulatory treatment of derivatives and of funding for large complex financial institutions – the global mega-banks – exacerbates this fragility. Perhaps we are moving in the right direction – that is, toward greater stability – but Hoenig is skeptical about the pace of progress.”

“As he points out, the relevant studies show that the mega-banks receive large implicit government subsidies, and this encourages them to stay big – and to take on a lot of risk. In principle, such subsidies are supposed to be phased out through measures being taken as a result of the 2010 Dodd-Frank financial-reform legislation. In practice, these subsidies – and the politics that makes them possible – are firmly entrenched.”

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Read full Global Times article here.

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