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Global Interdependence Center 2013 International Conference Series October 10, 2013 Hamilton, Bermuda

Harvey Rosenblum

Executive Vice President & Senior Economic Advisor Liz Organ Research Analyst The views expressed are those of the speaker and should not necessarily be attributed to the Federal Reserve Bank of Dallas or the Federal Reserve System.


Cool Hand Luke (1967)

“What  we’ve  got  here  is     failure  to  communicate”           §  Number  11  on  AFI’s  “100  Years…  100  Movie  Quotes”  list   SOURCE: Cool Hand Luke (movie, 1967)


Crisis Communication Technique …at  1mes  of  crisis,  Geithner  said  the  government  had  to   get  both  the  substance  and  the  theater  right.   Bernanke,  Geithner,  and  even  more  so,  Paulson  muffed   the  theater.  Because  they  didn’t  tell  a     convincing  story…  or  offer  a  clear     explana1on…  other  accounts  of  varying     plausibility  filled  the  vacuum…    

 -­‐  David  Wessel,  In  Fed  We  Trust,  p.  7-­‐8  


A Similar View from Inside the Fed §  “What  the  Fed  says  is  oFen  equally  important  to  

what  it  does,  and  oFen  more  so.  The  FOMC  moves   markets.”   –  Laurence  H.  Meyer,  A  Term  at  the  Fed:  An  Insider’s  View  

 

§  Harvey’s  and  Liz’s  corollary:  Silence  speaks,  too,  

and  oFen  more  loudly.  


Fed Statement Word Count Word count

More  words,     not  necessarily     more  meaning     or  understanding  

NOTE: The shaded area is the period of the FOMC’s unconventional monetary policy with interest rates at the effective lower bound of near zero. SOURCE: Wynne, Mark A., “A Short History of FOMC Communication,” Federal Reserve Bank of Dallas, Economic Letter, Sep. 2013.


§ In  theory,  monetary  policy  and  

regulatory  policy  are  separate.  

§ In  prac1ce,  they  are  the  same.   § Both  require  clear  communica1on.  


Communication Policy?

§ “Never  explain,  never  excuse.”   Montagu  Norman     Governor  of  the  Bank  of  England  (1920-­‐44)  

§ A  caricature  of  the  way  regulatory  policy  

is  communicated  today?  


Conventional Monetary Policy Decision to ease/tighten policy Target Fed funds rate Market interest rates

Bank capital linkage

Bank loan channel •  • 

Wellcapitalized banks

Interest rates Credit standards

Asset prices and wealth channel

Securities market channel •  • 

Interest rates Debt issuance

•  • 

Collateral values Net worth

Exchange rate channel

Confidence linkage

Strong consumer and business confidence

SOURCE: Rosenblum, Harvey, Jessica J. Renier, and Richard Alm, “Regulatory and Monetary Policies Meet ‘Too Big to Fail,’” Federal Reserve Bank of Dallas, Economic Letter, Apr. 2010.


Unconventional Monetary Policy Decision to ease policy Fed funds rate near lower bound

Large-scale purchases of long-term assets (QE)

Market interest rates

Bank capital linkage

Bank loan channel •  • 

Wellcapitalized banks

Interest rates Credit standards

Asset prices and wealth channel

Securities market channel •  • 

Interest rates Debt issuance

•  • 

Collateral values Net worth

Exchange rate channel

Confidence linkage

Strong consumer and business confidence

SOURCE: Rosenblum, Harvey, Jessica J. Renier, and Richard Alm, “Regulatory and Monetary Policies Meet ‘Too Big to Fail,’” Federal Reserve Bank of Dallas, Economic Letter, Apr. 2010.


Easy Monetary Policy Adds to Housing Bubble §  From  2002-­‐05,  in  the  midst  of  the  housing  bubble,  FOMC  

dissents  were  limited  and  erred  in  the  wrong  direc1on   –  Only  4  dissents,  all  in  favor  of  looser  policy  

Can  we  expect  be6er  from  the  FOMC  in  the  future?   Percent

9 8 7 6 5 4 3 2 1 0

Target Fed Funds Rate

'90

'92

'94

'96

Average (‘02-‘05): ~1.85%

'98

'00

'02

'04

'06

'08

'10

'12

SOURCES: Federal Reserve Board; Wynne, Mark A., “A Short History of FOMC Communication,” Federal Reserve Bank of Dallas, Economic Letter, Sep. 2013.


Recovery in Per Capita Output Weaker than in Previous Cycles

Average of prior cycles

2007:Q1–2013:Q2

Current recovery is 11% below average

NOTE: The shaded area indicates the range of major recessions since 1960, excluding the short 1980 recession. SOURCE: Luttrell, David, Tyler Atkinson, and Harvey Rosenblum, “Assessing the Costs and Consequences of the 2007-09 Financial Crisis and its Aftermath,” Federal Reserve Bank of Dallas, Economic Letter, Sep. 2013.


Recovery in Per Capita Output Weaker than in Previous Cycles §  Weak  recovery  despite  the  most  easy,  

expansionary  monetary  policy  in  history  

§  Cannot  overcome  undercapitalized  banks  and  

weak  confidence  

§  Repeat:  monetary  and  regulatory  policies    

are  not  independent  


Crisis Dramatically Lowers Income Expectations

Median, Apr. ’03-Apr. ‘08: 9.8

Net percent of respondents that expect their income to increase

Median, May ’08-Aug. ‘13: -3.0

NOTE: Gray bars indicate recessions. SOURCE: The Conference Board; Atkinson, Tyler, David Luttrell, and Harvey Rosenblum, “How Bad Was It? The Costs and Consequences of the 2007-09 Financial Crisis,” Federal Reserve Bank of Dallas, Staff Papers, July 2013.


Cost of the 2008-09 Financial Crisis §  Lost  Output:  $6-­‐14  trillion   §  Lost  Income  per  household:  $50-­‐120  thousand   §  Reduced  consump1on:  $15-­‐30  trillion   §  Plus:  psychological  and  other  trauma  costs  

Bo^om  Lines:     –  At  least  one  year  of  output  down  the  drain   –  Be^er  communica1on  could  have  reduced  these  costs   SOURCE: Luttrell, David, Tyler Atkinson, and Harvey Rosenblum, “Assessing the Costs and Consequences of the 2007-09 Financial Crisis and its Aftermath,” Federal Reserve Bank of Dallas, Economic Letter, Sep. 2013.


Too Big to Fail: Never Fixed

§  “…the  largest  financial  ins1tu1ons  are  a  dagger  

pointed  at  the  heart  of  our  economy.”  

–  Richard  W.  Fisher  and  Harvey  Rosenblum,    

Dallas  Morning  News,  Sep.  13,  2013  


Why the Persistence? §  A  subsidy,  once  given,  is  nearly  impossible  to  

remove,  and  the  TBTF  subsidy  is  huge  

§  “Smart  regula1on”  is  a  worthy  goal,  but    

difficult  to  achieve  

§  Unlike  in  other  industries,  most  banks,  but  especially  

large  banks,  are  legally  protected  from  changes  in   corporate  control  


Why the Persistence? Public  policy  makes  banks  special    

1.  Federal  Deposit  Insurance  (Safety)   2.  Access  to  Federal  Reserve  liquidity—Standing  Credit  Facility/   3.  4.  5.  6.  7.  8.  9. 

Lender  of  Last  Resort   Limited  entry  (supports  profitability)     Separate  resolu`on  (bankruptcy)  process   Provide  means  of  payment  (liabili`es  are  MONEY)   Dominate  the  networked  payments  system    (cri`cal  that  the  payments   system  be  “open  and  opera`ng”  7x24x365   Conduit  of  monetary  policy   Lender  of  first  resort  to  small  businesses—Standing  Credit  Facility   Minimum  capital  requirements  imposed  by  law  and  regula`on,  which  in   prac`ce  restricts  dividend,  salary  and  bonus  payments  


Why the Persistence?

Since  2008,  public  policy  makes   megabanks  super-­‐special   1.  Triage  regime:  Giant  banks  first  to  be  “saved”  by  first  

 

responders   2.  Escape  hatch:  Ager  their  “Lehman  Moment,”  Goldman   Sachs  and  Morgan  Stanley  chose  to  become  bank  holding   companies     3.  SIFIs:    Label  codifies  the  “systemic  importance”  of  certain   financial  ins`tu`ons    


What Do the Markets Say? The  stock  market  suggests  the  need  for  simplifying,     right-­‐sizing  and  reorganizing  –  But  Nobody’s  Listening!   Average price-to-tangible book value ratio 4.5   4.0  

Huge, complex banks

3.8  

(JP Morgan, BofA, Citigroup, Goldman, Morgan Stanley)

3.5   3.0  

Large but less complex banks

3.0  

(Wells Fargo, U.S. Bancorp, BB&T, SunTrust, Fifth Third)

2.5   2.0  

1.6  

1.5  

1.0  

1.0   0.5   0.0   2006   SOURCE: Bloomberg.

2007  

2008  

2009  

2010  

2011  

2012  

Q1  2013  


The Virtues of Community Banking §  Community  banking  model  is  largely  based  on    

long-­‐term  rela1onships  rather  than  short-­‐term   gains   –  During  the  subprime  crisis,  community  banks  had  fewer  loan  

quality  problems  (across  loan  types)  and  less  asset  impairment   than  bigger  banks  

–  Small  banks  focus  on  lending  to  businesses,  par@cularly  small  

ones,  that  larger  banks  do  not,  and  their  business  loan  volume   held  up  beher  during  the  crisis   –  More  recently,  small  banks  have  grown  their  loan  books  more:   In  Q2,  loans  at  small  banks  grew  at  an  annual  rate  of  4.7%;  the   comparable  rate  for  the  25  largest  banks  was  less  than  1%   SOURCE: “Special Report” essays from the Dallas Fed’s 2012 Annual Report; Federal Reserve Board H.8 data.


A Lopsided Financial System §  Community  and  regional  banks:  99.8%  of  all  banking  

ins1tu1ons  

–  Subject  to  discipline  from  regulators  and  shareholders/creditors   –  Can  fail  and  be  resolved  with  rela`ve  speed  (faster  for  smaller  

ins`tu`ons)  

§  Megabanks:  0.2%  of  all  banking  ins1tu1ons   –  Limited  discipline  from  any  source   –  Not  allowed  to  fail,  but  would  take  a  long  `me  to  resolve    

if  they  ever  were  

SOURCE: “Special Report” essays from the Dallas Fed’s 2012 Annual Report.


The Dallas Fed Plan 1.  Limit  safety  net  protec1on  to  tradi1onal  

commercial  banks  

2.  Require  creditors  to  acknowledge  that  they  have  

no  federal  guarantee  by  signing  a  simple  disclaimer  

3.  Encourage  management  to  restructure  large  

ins1tu1ons  so  that  banking  en11es  are     “Too  Small  to  Save”  

 


Moving in the Right Direction, but Too Slowly §  Recent  spinoffs:  Ci1  shedding  some  “alterna1ve  

assets,”  BofA  closing  out  its  ownership  stake  in   China  Construc1on  Bank,  and  GE  dives1ng  its  credit   card  business  

§  Some  banks  have  begun  exi1ng  business  that  are  

“reputa1onally  or  ethically  problema1c”  

–  Patrick  Jenkins,  “HSBC  mindful  of  sharp  edges  on  its  ‘sword  of  

Damocles,’”  Financial  Times,  Sep.  16,  2013  

§  Not  just  regulatory  policy:  Banking  ins1tu1ons  hold  

about  90%  of  our  money  supply  and  the  dollar  is  a   faith-­‐based  currency  

NOTE: Currency and travelers checks only account for 10.6% of the total M2 money stock, leaving the other 89.4% at banking institutions in the form of demand, savings, and time deposits and retail money funds.


Dallas Fed Plan Not All That Radical §  The  penalty  is  propor1onal  to  the  downside  risks  

imposed  by  TBTF  

–  One  year  of  output  down  the  drain,  again?  

§  Half  measures  will  not  work  and  will  not  result  in  a  

credible  regime  shiF   §  Stock  market  prices  underscore  need  for  Dallas  Fed  Plan   §  Far  less  radical  than  quasi-­‐na1onalizing  many  

megabanks  in  2008-­‐09  


Why We Cannot Rely on Dodd-Frank

§  “Simplify  and  codify  quickly.”   –  Harvey  Rosenblum,  Dallas  Fed’s  2011  Annual  Report  

§  Cannot  enforce  if  rules  unwri^en  


The Pathology of TBTF

Adverse  feedback  loop    

Immune   from   failure  

Some  banks   seen  as  TBTF  

Immune  from   prosecu1on  

Cost   advantage  

TBTF  banks   grow  bigger  

Deemed  even   more  TBTF  


The Pathology of TBTF

How  to  break  the     adverse  feedback  loop:   Dallas  Fed  Plan   eliminates  this     destruc1ve  ambiguity      

Immune   from   failure  

Some  banks   seen  as  TBTF  

Immune  from   prosecu1on  

Cost   advantage  

TBTF  banks   grow  bigger  

Deemed  even   more  TBTF  


Conclusion §  Communica1on  and  ac1on  needed  to  alter  the  

percep1on  that  giant  banks  are  forever  TBTF  

§  Dallas  Fed  Plan  clarifies  that  no  banking  

ins1tu1ons  are  TBTF  

§  Why?  Because  reorganiza1on  and  downsizing  of  

the  giants  makes  this  statement  credible  


Rosenblum, harvey