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
