Fed Bank of Minneapolis Symposium on TBTF
Federal Reserve Bank of Minneapolis
Second Symposium on Ending Too Big to Fail
Monday, May 16, 2016
Key Topics & Takeaways
- Minneapolis Fed’s Proposal: Kashkari stated that the Minneapolis Fed’s plan for ending TBTF will be released at the end of the year.
- Benefits of Large Financial Institutions: Hasenstab reported that while there are problems with large banks, they have an important function that allows U.S. investors and corporations to operate on a global scale, and that scaling large banks back will inhibit their global reach, ultimately resulting in a loss to U.S. competitiveness. Bernanke added that in the long-run, a U.S. financial industry without a large financial firm would likely be less efficient, thus providing fewer services at higher cost.
- Alternatives to the Dodd-Frank Act’s Resolution Framework: Bernanke stated that progress has been made, but there is still more to achieve in order to end TBTF, adding that “there will need to be major structural changes in the financial services industry,” and stated his belief that the first step should deal with uncertainty in the regulatory process.
Speakers
- Neel Kashkari, President, Federal Reserve Bank of Minneapolis
- John H. Cochrane, Senior Fellow at the Hoover Institution, Stanford University
- Michael Hasenstab, Executive Vice President & Chief Investment Officer at Templeton Global Macro
- Michael Keen, Deputy Director of the Fiscal Affairs Department, International Monetary Fund
- Donald Marron, Institute Fellow and Director of Economic Policy Initiatives at the Urban Institute
- Thomas Philippon, Professor of Finance at the NYU Stern School of Business
- Luigi Zingales, Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and Charles M. Harper Faculty Fellow, University of Chicago Booth School of Business
- John Bovenzi, Co-chair of the Bipartisan Policy Center’s Failure Resolution Task Force
- Ben S. Bernanke, Distinguished Fellow in Residence, Economic Studies, Brookings Institution
- J. Christopher Flowers, Managing Director and CEO of J.C. Flowers & Co.
- Richard J. Herring, Jacob Safra Professor of International Banking and Professor of Finance, Wharton School, University of Pennsylvania
- David A. Skeel, S. Samuel Arsht Professor of Corporate Law, University of Pennsylvania Law School
Welcoming Remarks
Neel Kashkari, President, Federal Reserve Bank of Minneapolis
In his opening remarks, Kashkari questioned whether the financial services industry has done enough to address too big to fail (TBTF) and questioned what risks remain unaddressed. He stated that the Minneapolis Fed’s plan for ending TBTF will be released at the end of the year, and while the first symposium focused on increasing the capital of banks and breaking up the large banks, this symposium would focus on taxing leverage to reduce systemic risk and alternative resolution mechanisms.
Panel One: Taxing Leverage in the Financial System
John H. Cochrane, Senior Fellow at the Hoover Institution, Stanford University
Cochrane discussed his proposal for ending TBTF and stressed that to stop a financial crisis, it is imperative to know the economic environment is “good enough” and when to stop “trying to fix things” in the name of crisis prevention. He noted objections to his vision, including the fear of a lack of credit flow that would lead to the economy “dry[ing] up,” which he dismissed as a “false” notion. Cochrane explained that disincentives and bad regulations, such as tax distortion, debt guarantees, and regulations that encourage holding debt, should be removed to end TBTF, and that his strongest suggestion for ending TBTF is regulatory relief. He continued that rather than repealing the Dodd-Frank Act, a safe harbor should be added because it is “attractive,” and argued that rather than using ratios for ensuring financial stability, a Pigouvian tax on debt is needed.
Michael Hasenstab, Executive Vice President & CIO, Templeton Global Macro
Hasenstab explained several questions that should be explored in ending TBTF, including: 1) whether one problem being solved is creating another problem; 2) how to get to 100 percent equity logistically; and 3) whether there are short-term macro implications that could further the economic recession. He disagreed that the financial markets could get to 100 percent equity, as it would drive down stock prices and create a “vicious cycle,” and that instead credit should be grown by “unconventional” policies. Hasenstab continued that while there are problems with large banks, they have an important function that allows U.S. investors and corporations to operate on a global scale, and that scaling large banks back will inhibit their global reach, ultimately resulting in a loss to U.S. competitiveness.
Michael Keen, Deputy Director of the Fiscal Affairs Department, International Monetary Fund
Keen questioned whether the debt bias in the tax system matters in the financial sector, and explained options for eliminating such a bias: 1) eliminating interest deductibility; and 2) giving equity the same treatment that interest receives, including the adoption of an allowance for corporate equity (ACE). Regarding ACE, he continued that several countries have this in place, including Belgium, Italy, Brazil, and Austria, stressing that it is “not an outrageous proposal.”
Donald Marron, Institute Fellow and Director of Economic Policy Initiatives, Urban Institute
Marron stressed that the idea of taxing “problematic things,” such as alcohol and cigarettes, is wide-spread throughout the economy and that there is a concern about externalities and moral hazard. He continued that government policies could be causing such problems in the economy and that taxing such items could “add to the problem.” Marron discussed the difference between a tax approach and regulatory approach being the cost, which impacts the political economy due to taxes and fees.
Thomas Philippon, Professor of Finance, NYU Stern School of Business
Philippon explained that narrowing banking will not stop all runs, and that as long as assets are illiquid, there will remain a first-mover advantage. He continued that while moving to 100 percent equity would mean fewer runs, it would not eliminate them. Philippon stressed that regarding taxing leverage, there are several decisions that need to be made, to include a safe harbor versus automatic stay, and local leverage versus global leverage, and added that while it is a great idea, it is “easier said than done.”
Audience Discussion
An audience member questioned whether Cochrane’s proposal creates additional taxes and constraints on the financial system. Cochrane replied that his proposal would have less constraints on the financial system and “much more growth.” He continued that the current system includes a “huge” amount of regulation, but that a safe harbor and removing subsidies on debt “would do the trick.”
Another audience member criticized the Basel framework and Dodd-Frank Act, stating that they are the “opposite of keep it simple,” and asked whether Cochrane’s proposal would make the regulatory regime more simple or complex. Philippon explained that there is “no point in trying to find an economic rationale behind Basel,” but that having multiple ratios is not complex. Cochrane added that rules need to be complex in order to prevent banks and financial institutions from being able to work around them.
When asked whether the new tax on debt finance should be a global tax, Cochrane said yes, and that the goal is to make it attractive so banks “will come running” if there is a new regulatory safe harbor in return for changing their capital structures, adding that it would be the “great new wild west of competitive banking.”
Keynote: Why I Changed My Mind on Glass Steagall
Luigi Zingales, Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and Charles M. Harper Faculty Fellow, University of Chicago Booth School of Business
Zingales began his keynote by commenting that while he does not blame the financial crisis on the repeal of Glass-Steagall, he used to be moderately against the legislation due to it coming about by a “bad deal” among legislators and there not being enough compelling evidence that “problems were big.” He then explained the reasons why he changed his mind, and his first point was that he has been “disappointed” by the Volcker Rule due to it being “impossible.” Zingales’ second reason was due to the simplicity of Glass-Steagall, adding that the fewer provisions a piece of legislation has, the less expensive it is to enforce and the fewer loopholes that can be found.
Zingales further explained that Glass-Steagall promoted the development of the equity market in the U.S., as well as the resiliency of the independent banking and financial markets systems. Lastly, and most importantly, Zingales talked about the political power of banks, commenting that he has pushed for a political view of antitrust with “zero success.” He concluded that while Glass-Steagall is not “the perfect system by any means,” this combination of factors has led him to believe the economy would be better off today if Glass-Steagall was in place rather than the Volcker Rule.
Panel Two: Exploring Alternatives to the Dodd-Frank Act’s Resolution Framework
John Bovenzi,Co-chair of the Bipartisan Policy Center’s Failure Resolution Task Force
Bonvenzi discussed his proposal to explore alternatives to the Dodd-Frank Act’s resolution framework. He listed the six major developments that provide reason for optimism in ending TBTF as: 1) the change in attitude regarding the need to end TBTF; 2) the legislative framework for resolving insolvent banking organizations, thus requiring banks to develop credible living wills; 3) a significant increase in capital and liquidity at the largest bank organizations and their stress testing since the financial crisis; 4) the development of the Single Point of Entry (SPOE) resolution strategy, which deals with operational cross-border issues; 5) the recognition of the need to hold significant long-term subordinated debt; and 6) actions underway to prevent counterparties from terminating financial contracts upon insolvency. Bovenzi reported on the important steps that have to be taken by the Federal Deposit Insurance Corporation (FDIC) and the banking industry are adhering to the course of plan and ensuring there is greater clarity and transparency in the process.
Ben Bernanke, Distinguished Fellow in Residence, Economic Studies, Brookings Institution
Bernanke stated that progress has been made, but there is still more to achieve in order to end TBTF, adding that “there will need to be major structural changes in the financial services industry,” and stated his belief that the first step should deal with uncertainty in the regulatory process. Bernanke explained the potential advantages of size for banks not associated with TBTF status, including the ability to explore economies of scale, technology, establishing networks and branding, grave diversification of risk, the spreading of fixed overhead costs activities, and the ability to offer complimentary products and global reach. He added that in the long-run, a U.S. financial industry without a large financial firm would likely be less efficient, thus providing fewer services at higher cost. Bernanke described studies that showed size is not the only relevant attribute of banks systemic risk.
J. Christopher Flowers, Managing Director and CEP of J.C., Flowers & Co.
Flowers focused on the resolution framework from the perspective of an equity investor and a private equity investor. He stated that he “does not see this economy functioning with large financial institutions,” and affirmed that “if we are going to have large institutions, we cannot get rid of TBTF.” Flowers described the SPOE as “useful and a welcome mechanism,” but did not perceive it to be the solution to the problem of maintaining subsidiaries in various places that require liquidity and capital.
Richard J. Herring, Jacob Safra Professor of International Banking and Finance, Wharton School, University of Pennsylvania
Herring concentrated on resolution policy from a historical perspective. He listed the policies launched to prevent insolvency, including higher capital, increased risk weights, capital surcharges for global systemically important banks (G-SIBs), and the heightened prudential supervision including stress tests.
David A. Skeel, Professor of Corporate Law, University of Pennsylvania Law School
Skeel stated that for the past six years, the federal regulators have worked to reduce major financial companies’ probability of failure by requiring the implementation of enhanced capital, liquidity and other prudential requirements. He added that the goal was to “manage the largest banks, rather than to break them up.” With that, he reported three “cautionary comments” with this approach: 1) as a historical matter, the focus on managing the largest institutions versus scaling them down is surprising; 2) artificial cut-offs, such as penalties for banks to achieve a certain fixed number size, will work if banks are allowed to decide on their own how to downsize; and 3) implementing strict, simple, high-equity requirements. Skeel explained that the SPOE will only work if regulators set the total loss absorbing capacity (TLAC) requirements high enough and ensure it remains high. He concluded that SPOE and the bankruptcy quick sale are promising, but not yet ready.
Audience Discussion
Bovenzi stated that based on the testimonies of the panel there is mutual agreement on resolutions, the benefits of big financial institutions, the cost associated with “breaking them up,” and that their size is not the major problem.
An audience member questioned the panel on whether they believe the resolution process is headed in the right direction, as it is institution-focused rather than instrument-focused. Bernanke responded that if you assume there is a perceived, private benefit to the bailout probability which is not a social benefit, then presumably the equilibrium would be to have safer banks. He added that in order to achieve safer banks, it is essential to create the right incentives, including tougher regulations. Skeel explained that Dodd-Frank did not “completely ignore” the instruments and addressed the problems with swaps and other derivatives.
Another audience member proceeded to ask if the time frame is practical for identifying if a large financial institution is, for instance, solvent, but illiquid. Bovenzi assured that capital requirements need to be higher. He added that each agency has numerous examiners in the institutions monitoring on a daily basis to determine collateral.
For more information on this event, please click here.
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Federal Reserve Bank of Minneapolis
Second Symposium on Ending Too Big to Fail
Monday, May 16, 2016
Key Topics & Takeaways
- Minneapolis Fed’s Proposal: Kashkari stated that the Minneapolis Fed’s plan for ending TBTF will be released at the end of the year.
- Benefits of Large Financial Institutions: Hasenstab reported that while there are problems with large banks, they have an important function that allows U.S. investors and corporations to operate on a global scale, and that scaling large banks back will inhibit their global reach, ultimately resulting in a loss to U.S. competitiveness. Bernanke added that in the long-run, a U.S. financial industry without a large financial firm would likely be less efficient, thus providing fewer services at higher cost.
- Alternatives to the Dodd-Frank Act’s Resolution Framework: Bernanke stated that progress has been made, but there is still more to achieve in order to end TBTF, adding that “there will need to be major structural changes in the financial services industry,” and stated his belief that the first step should deal with uncertainty in the regulatory process.
Speakers
- Neel Kashkari, President, Federal Reserve Bank of Minneapolis
- John H. Cochrane, Senior Fellow at the Hoover Institution, Stanford University
- Michael Hasenstab, Executive Vice President & Chief Investment Officer at Templeton Global Macro
- Michael Keen, Deputy Director of the Fiscal Affairs Department, International Monetary Fund
- Donald Marron, Institute Fellow and Director of Economic Policy Initiatives at the Urban Institute
- Thomas Philippon, Professor of Finance at the NYU Stern School of Business
- Luigi Zingales, Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and Charles M. Harper Faculty Fellow, University of Chicago Booth School of Business
- John Bovenzi, Co-chair of the Bipartisan Policy Center’s Failure Resolution Task Force
- Ben S. Bernanke, Distinguished Fellow in Residence, Economic Studies, Brookings Institution
- J. Christopher Flowers, Managing Director and CEO of J.C. Flowers & Co.
- Richard J. Herring, Jacob Safra Professor of International Banking and Professor of Finance, Wharton School, University of Pennsylvania
- David A. Skeel, S. Samuel Arsht Professor of Corporate Law, University of Pennsylvania Law School
Welcoming Remarks
Neel Kashkari, President, Federal Reserve Bank of Minneapolis
In his opening remarks, Kashkari questioned whether the financial services industry has done enough to address too big to fail (TBTF) and questioned what risks remain unaddressed. He stated that the Minneapolis Fed’s plan for ending TBTF will be released at the end of the year, and while the first symposium focused on increasing the capital of banks and breaking up the large banks, this symposium would focus on taxing leverage to reduce systemic risk and alternative resolution mechanisms.
Panel One: Taxing Leverage in the Financial System
John H. Cochrane, Senior Fellow at the Hoover Institution, Stanford University
Cochrane discussed his proposal for ending TBTF and stressed that to stop a financial crisis, it is imperative to know the economic environment is “good enough” and when to stop “trying to fix things” in the name of crisis prevention. He noted objections to his vision, including the fear of a lack of credit flow that would lead to the economy “dry[ing] up,” which he dismissed as a “false” notion. Cochrane explained that disincentives and bad regulations, such as tax distortion, debt guarantees, and regulations that encourage holding debt, should be removed to end TBTF, and that his strongest suggestion for ending TBTF is regulatory relief. He continued that rather than repealing the Dodd-Frank Act, a safe harbor should be added because it is “attractive,” and argued that rather than using ratios for ensuring financial stability, a Pigouvian tax on debt is needed.
Michael Hasenstab, Executive Vice President & CIO, Templeton Global Macro
Hasenstab explained several questions that should be explored in ending TBTF, including: 1) whether one problem being solved is creating another problem; 2) how to get to 100 percent equity logistically; and 3) whether there are short-term macro implications that could further the economic recession. He disagreed that the financial markets could get to 100 percent equity, as it would drive down stock prices and create a “vicious cycle,” and that instead credit should be grown by “unconventional” policies. Hasenstab continued that while there are problems with large banks, they have an important function that allows U.S. investors and corporations to operate on a global scale, and that scaling large banks back will inhibit their global reach, ultimately resulting in a loss to U.S. competitiveness.
Michael Keen, Deputy Director of the Fiscal Affairs Department, International Monetary Fund
Keen questioned whether the debt bias in the tax system matters in the financial sector, and explained options for eliminating such a bias: 1) eliminating interest deductibility; and 2) giving equity the same treatment that interest receives, including the adoption of an allowance for corporate equity (ACE). Regarding ACE, he continued that several countries have this in place, including Belgium, Italy, Brazil, and Austria, stressing that it is “not an outrageous proposal.”
Donald Marron, Institute Fellow and Director of Economic Policy Initiatives, Urban Institute
Marron stressed that the idea of taxing “problematic things,” such as alcohol and cigarettes, is wide-spread throughout the economy and that there is a concern about externalities and moral hazard. He continued that government policies could be causing such problems in the economy and that taxing such items could “add to the problem.” Marron discussed the difference between a tax approach and regulatory approach being the cost, which impacts the political economy due to taxes and fees.
Thomas Philippon, Professor of Finance, NYU Stern School of Business
Philippon explained that narrowing banking will not stop all runs, and that as long as assets are illiquid, there will remain a first-mover advantage. He continued that while moving to 100 percent equity would mean fewer runs, it would not eliminate them. Philippon stressed that regarding taxing leverage, there are several decisions that need to be made, to include a safe harbor versus automatic stay, and local leverage versus global leverage, and added that while it is a great idea, it is “easier said than done.”
Audience Discussion
An audience member questioned whether Cochrane’s proposal creates additional taxes and constraints on the financial system. Cochrane replied that his proposal would have less constraints on the financial system and “much more growth.” He continued that the current system includes a “huge” amount of regulation, but that a safe harbor and removing subsidies on debt “would do the trick.”
Another audience member criticized the Basel framework and Dodd-Frank Act, stating that they are the “opposite of keep it simple,” and asked whether Cochrane’s proposal would make the regulatory regime more simple or complex. Philippon explained that there is “no point in trying to find an economic rationale behind Basel,” but that having multiple ratios is not complex. Cochrane added that rules need to be complex in order to prevent banks and financial institutions from being able to work around them.
When asked whether the new tax on debt finance should be a global tax, Cochrane said yes, and that the goal is to make it attractive so banks “will come running” if there is a new regulatory safe harbor in return for changing their capital structures, adding that it would be the “great new wild west of competitive banking.”
Keynote: Why I Changed My Mind on Glass Steagall
Luigi Zingales, Robert C. McCormack Distinguished Service Professor of Entrepreneurship and Finance and Charles M. Harper Faculty Fellow, University of Chicago Booth School of Business
Zingales began his keynote by commenting that while he does not blame the financial crisis on the repeal of Glass-Steagall, he used to be moderately against the legislation due to it coming about by a “bad deal” among legislators and there not being enough compelling evidence that “problems were big.” He then explained the reasons why he changed his mind, and his first point was that he has been “disappointed” by the Volcker Rule due to it being “impossible.” Zingales’ second reason was due to the simplicity of Glass-Steagall, adding that the fewer provisions a piece of legislation has, the less expensive it is to enforce and the fewer loopholes that can be found.
Zingales further explained that Glass-Steagall promoted the development of the equity market in the U.S., as well as the resiliency of the independent banking and financial markets systems. Lastly, and most importantly, Zingales talked about the political power of banks, commenting that he has pushed for a political view of antitrust with “zero success.” He concluded that while Glass-Steagall is not “the perfect system by any means,” this combination of factors has led him to believe the economy would be better off today if Glass-Steagall was in place rather than the Volcker Rule.
Panel Two: Exploring Alternatives to the Dodd-Frank Act’s Resolution Framework
John Bovenzi,Co-chair of the Bipartisan Policy Center’s Failure Resolution Task Force
Bonvenzi discussed his proposal to explore alternatives to the Dodd-Frank Act’s resolution framework. He listed the six major developments that provide reason for optimism in ending TBTF as: 1) the change in attitude regarding the need to end TBTF; 2) the legislative framework for resolving insolvent banking organizations, thus requiring banks to develop credible living wills; 3) a significant increase in capital and liquidity at the largest bank organizations and their stress testing since the financial crisis; 4) the development of the Single Point of Entry (SPOE) resolution strategy, which deals with operational cross-border issues; 5) the recognition of the need to hold significant long-term subordinated debt; and 6) actions underway to prevent counterparties from terminating financial contracts upon insolvency. Bovenzi reported on the important steps that have to be taken by the Federal Deposit Insurance Corporation (FDIC) and the banking industry are adhering to the course of plan and ensuring there is greater clarity and transparency in the process.
Ben Bernanke, Distinguished Fellow in Residence, Economic Studies, Brookings Institution
Bernanke stated that progress has been made, but there is still more to achieve in order to end TBTF, adding that “there will need to be major structural changes in the financial services industry,” and stated his belief that the first step should deal with uncertainty in the regulatory process. Bernanke explained the potential advantages of size for banks not associated with TBTF status, including the ability to explore economies of scale, technology, establishing networks and branding, grave diversification of risk, the spreading of fixed overhead costs activities, and the ability to offer complimentary products and global reach. He added that in the long-run, a U.S. financial industry without a large financial firm would likely be less efficient, thus providing fewer services at higher cost. Bernanke described studies that showed size is not the only relevant attribute of banks systemic risk.
J. Christopher Flowers, Managing Director and CEP of J.C., Flowers & Co.
Flowers focused on the resolution framework from the perspective of an equity investor and a private equity investor. He stated that he “does not see this economy functioning with large financial institutions,” and affirmed that “if we are going to have large institutions, we cannot get rid of TBTF.” Flowers described the SPOE as “useful and a welcome mechanism,” but did not perceive it to be the solution to the problem of maintaining subsidiaries in various places that require liquidity and capital.
Richard J. Herring, Jacob Safra Professor of International Banking and Finance, Wharton School, University of Pennsylvania
Herring concentrated on resolution policy from a historical perspective. He listed the policies launched to prevent insolvency, including higher capital, increased risk weights, capital surcharges for global systemically important banks (G-SIBs), and the heightened prudential supervision including stress tests.
David A. Skeel, Professor of Corporate Law, University of Pennsylvania Law School
Skeel stated that for the past six years, the federal regulators have worked to reduce major financial companies’ probability of failure by requiring the implementation of enhanced capital, liquidity and other prudential requirements. He added that the goal was to “manage the largest banks, rather than to break them up.” With that, he reported three “cautionary comments” with this approach: 1) as a historical matter, the focus on managing the largest institutions versus scaling them down is surprising; 2) artificial cut-offs, such as penalties for banks to achieve a certain fixed number size, will work if banks are allowed to decide on their own how to downsize; and 3) implementing strict, simple, high-equity requirements. Skeel explained that the SPOE will only work if regulators set the total loss absorbing capacity (TLAC) requirements high enough and ensure it remains high. He concluded that SPOE and the bankruptcy quick sale are promising, but not yet ready.
Audience Discussion
Bovenzi stated that based on the testimonies of the panel there is mutual agreement on resolutions, the benefits of big financial institutions, the cost associated with “breaking them up,” and that their size is not the major problem.
An audience member questioned the panel on whether they believe the resolution process is headed in the right direction, as it is institution-focused rather than instrument-focused. Bernanke responded that if you assume there is a perceived, private benefit to the bailout probability which is not a social benefit, then presumably the equilibrium would be to have safer banks. He added that in order to achieve safer banks, it is essential to create the right incentives, including tougher regulations. Skeel explained that Dodd-Frank did not “completely ignore” the instruments and addressed the problems with swaps and other derivatives.
Another audience member proceeded to ask if the time frame is practical for identifying if a large financial institution is, for instance, solvent, but illiquid. Bovenzi assured that capital requirements need to be higher. He added that each agency has numerous examiners in the institutions monitoring on a daily basis to determine collateral.
For more information on this event, please click here.