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Looking at Hoenig on the Dodd Bill

Anthony Randazzo
April 19, 2010, 10:23am

Kansas City Federal Reserve Bank President Thomas Hoenig writing in The New York Times Saturday makes a couple of sharp critiques of the Dodd financial services reform bill. His theme is that "the proposal for regulatory reform now before the Senate does not eliminate the concept of too-big-to-fail, and it deliberately narrows the central bank’s focus to Wall Street alone."

On the first issue—the fact that the Dodd bill continues TBTF—he argues that the proposed resolution authority, ironically, "might not be timely enough" since it would require the Treasury petitioning the judiciary and be dependent on winning approval. In Hoenig's view "the new law should require that any institution deemed insolvent, based on an established, objective set of criteria, be placed into receivership and resolved in an orderly fashion — just as banks on Main Street are."

While I am still suspect of the FDIC-style receivership model, overall I don't think they would necessarily capable of winding down an institution better than bankruptcy courts, the idea that there should be an objective standard for insolvency is a good idea. In fact, it is something I also wrote about back in January:

In addition to more rapid adjudication, objective standards defining when a firm is insolvent could be agreed upon so that shocks in the marketplace are limited. And policies could be put in place that clearly order the distribution of assets in honoring contracts with failed firms, with subordinated investments getting larger returns but the last pieces of a collection. The Treasury Department would also have to commit to honoring this structure, unlike their handling of debt and equity holders at firms bailed out during the crisis.

On the second issue—the idea that Dodd is narrowing the Fed's scope to just Wall Street—I agree in principle with Hoenig, but not in solution. He isn't way off base in noting that:

Congress established the Federal Reserve System in 1913 with 12 banks in a federated structure, like our political system, so that it would include regional perspectives to counterbalance the influence of Wall Street and Washington. To now narrow the Fed’s supervision to just the largest banks would be to devalue those broader perspectives. The Federal Reserve would no longer be the central bank of the United States, but only the central bank of Wall Street... By this reasoning, the 6,700 other banks and the communities they serve are of no immediate consequence to the mission of the Federal Reserve.

However, the problem, from my perspective, is that the Fed has any banking oversight authority at all. I think it would be much better to have a single agency tasked with ensuring banks at all levels follow the law. This agency would have to avoid one-size fits all policies, but that wouldn't be hard to avoid as long as the agency directors were aware of the drawbacks of trying to regulate large banks the same way small banks should be regulated. The Fed should be a central bank concerned with monetary policy. Not as the overseer of the whole financial system or even the economy in general. A separate banking and consumer protection agency could perform all banking oversight functions required to effectively "regulate"—i.e. ensure banks follow the law and don't commit fraud or abuse people.


Anthony Randazzo is Director of Economic Research


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