FIGHTING TO REIN IN BIG BANKS´ POWER / BARRON´S FEATURE ( HIGHLY RECOMMENDED READING )

Monday, September 14, 2009

FEATURE

Fighting to Rein In Big Banks' Power

By JACK WILLOUGHBY

The longest-serving member of the Federal Open Market Committee warns that our "too-big-to-fail" banking policy must be abolished now.

THE GLOBAL BANKING CONFERENCE at Jackson Hole, Wyo., last month proved a springboard for Federal Reserve Chairman Ben Bernanke's reappointment. The real news was what wasn't on the menu: "too big to fail."

The topic is dear to the heart of conference host Thomas M. Hoenig, the 63-year-old president of the Kansas City, Mo., Federal Reserve Bank and the longest-serving member of the Fed's policy-making Federal Open Market Committee.

According to the Kansas City Fed's Thomas Hoenig: "The Fed has encouraged merging sick banks into larger ones, a process that tends to concentrate risk."

In June Hoenig stirred up controversy when he accused the federal government of "regulatory malpractice" by creating another regulatory regime without addressing "too big to fail." He warned of an "oligarchy of interest that will fail to serve the best interests of business, the consumer and the U.S. economy." Investors are likely to hear a lot more about Hoenig's views shortly, as the government begins to address regulatory shortcomings exposed by the financial crisis.

Some financial journalists expected a slugfest over this issue at Jackson Hole. They were wrong. Hoenig not only struck the topic from the agenda, but refused even to be interviewed about it. "The conference should never serve the political agenda of any one person, particularly its host," explained Hoenig, who first went to work at the Kansas City Fed in 1973.

With the conference concluded, however, Hoenig has resumed his campaign in op-ed articles in major newspapers. His main point: Talk about the prudent supervision of banks is putting the cart before the horse; standing in the way of real reform is failure to find a means of systematically dealing with the too-big-to-fail policy.

The phrase describes the special status apparently conferred on America's biggest banks, which have received billions in taxpayer bailouts and guarantees in the name of keeping the financial system working. The federal government through bailouts has placed them beyond the normal penalties for failure -- receivership, bankruptcy and disgrace. These big banks also happen to be among the largest contributors to both political parties.

To Hoenig, they represent the new aristocracy of U.S. commerce. For months the Kansas City Fed chief has called for policymakers to create a plan to break up the most insolvent of these institutions, putting them first into receivership. "If we hesitate to make needed changes," he says, "we will perpetuate an oligarchy of interest." Chairman Bernanke has said he doesn't favor "too big to fail" policies. But he links their removal to expanded regulatory powers, including the possibility of rehabilitation.

The concentration of power among a few mega-banks troubles Hoenig. "I've seen banks close for making mistakes," says Hoenig. "I've seen other banks too big for the regulators, being supported by the U.S. taxpayer. It's harmful to the infrastructure, and sends the wrong message, that influence is what really matters. If we fail to address 'too big to-fail,' it will only get worse."

Hoenig is probably the most visible proponent of the traditionalist view of Federal Reserve governance -- a view that opposed many of the emergency measures applied in the financial crisis. The billions flushed into the banking system have led to a doubling of the Fed's balance sheet in the name of averting global calamity -- and to what traditionalists perceive as a loss of independence for the Fed.

The opposing, globalist school considers the 12 regional Federal Reserve banks as anachronisms, useful in the telegraph era but useless in the telecommunications age. They see a natural need to centralize power with the likes of Bernanke, Treasury Secretary Tim Geithner and Larry Summers, director of the National Economic Council, to work for the interests of the global financial system.

Traditionalists believe the consensus reached by the 12 regional banks serves as a brake on the global designs of the power elite who oversee the East Coast's biggest banks and brokerage firms. In this view, each regional bank functions as an information gatherer, calling upon banks, businesses, labor leaders and farmers to get their perspectives on the regional economy, and feeding those views to Washington. Traditionalists also question Bernanke's close collaboration with Geithner's Treasury. They fear a serious loss of its historical independence in the process, which would amount to a violation of the Fed Board's duty to serve as a check on Washington politicians.

"The distrust of centralization and monolithic power is a theme throughout American history. This should not be lost on Americans," says Hoenig. One has only to look at the expiration of the charter of the first U.S. Bank, or the dismantling of the second U.S. Bank by Andrew Jackson, to get some sense of the history. "Today," he notes, "the top 20 banks own 70% of the [banking system's] assets."

In fact, argues Hoenig, the Fed has been behind the process of creating the giants that today tower over the financial industry. "Because of too-big-to-fail, the Fed has encouraged merging sick banks into larger ones, a process that tends to concentrate risk."

Earlier this year Hoenig's Kansas City Fed published an 80-page primer called the "Balance of Power: The Political Fight for an Independent Central Bank" (www.kc.frb.org), which outlines a traditionalist interpretation of U.S. financial history. The tract, says Hoenig, has received a favorable response from Fed directors -- regional-bank directors -- across the country.

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