Thomas Hoenig has seen a pattern repeat in his 43-year career overseeing banks: A financial crisis hits and then fades out of memory after about 10 years. The bankers responsible eventually leave the firm, and new MBAs come in. In time, no one is left who remembers what went wrong.
Not so for Hoenig, who served 38 years in the Federal Reserve system supervising banks before becoming the vice chairman of the Federal Deposit Insurance Commission in 2012. Hoenig has served through at least four financial crises and hasn’t forgotten any. “Experience is the best Ph.D. you can have,” said Hoenig, who also has a Ph.D. in economics from Iowa State University.
The possibility of a banking crisis is a special fear for the FDIC. It is the agency responsible for maintaining the system of insurance for deposits at banks, and if a bank fails, it is responsible for taking it over and making sure depositors get their money back. Following the 2010 Dodd-Frank law, the FDIC is also responsible for developing the plan for when another megabank fails and needs the government to take it over and pay out its creditors.
No one in the regulatory system is more outspoken about preventing bailouts than Hoenig. For his criticism of the existence of banks that are “too big to fail,” which means that the market expects the government to rescue them if they get into trouble, Hoenig has fans among liberals. A self-professed “market person,” however, he also is respected on the right. Republicans also approved of his advocacy of tighter monetary policy during his tenure as the president of the Federal Reserve Bank of Kansas City. In recent months, Hoenig’s name has surfaced as a possible pick for a top financial post in the Trump administration.
In the meantime, Hoenig is trying to advance a major overhaul of the banking system aimed at ending bailouts of big banks. His plan would partition megabanks into two parts: one made up of traditional banking, which gets FDIC insurance, and the other made up of all the other lines of business undertaken by today’s megabanks that aren’t traditional deposit-taking and lending, such as investment banking and insurance.
The point, Hoenig said, is that the government safety net for deposits wouldn’t extend to risky trades done in the nontraditional part of the bank. As a result, investors would price the two parts of the megabank, which would be split into two stocks, appropriately for the risks they engage in. Gone would be the subsidy big banks get for the perception that they are in line for a bailout, which Hoenig compared to agricultural subsidies.
The Washington Examiner spoke with Hoenig in his Washington office to discuss his vision for the banking industry.
Washington Examiner: Why is this plan necessary now?
Hoenig: I think, as much as we would like to conclude that too-big-to-fail has been solved, I don’t believe it has. I think you still have the commingling of very high-risk activities under the deposit insurance system, with the moral hazard that goes with that. You have these very large, complex, interconnected, undercapitalized institutions. You still have too-big-to-fail. This is to help solve that more fundamental problem.
I’ve said, since the beginning, my goal is not to break them up and make them smaller for their own sake. My goal is to solve too-big-to-fail. That’s the goal. Because the market works best when you have symmetrical success or failure and you’re allowed to do both. That’s discipline in the market.
Washington Examiner: And what kind of feedback have you gotten from the industry, from banks?
Hoenig: I haven’t gotten a whole lot of feedback.
I mean, there’s always the view that, well, we can’t separate it out because it’s too difficult, too complex. But I believe it can be separated out. It’s been separated out in the past. And this doesn’t require that they divest of it. It only requires that they identify them as separate activities.
We know that commercial firms do that all the time, with tracking shares and separate entities within their organization so the market can price accordingly. Here you have a traditional bank, priced in the market, and you have the more risky broker-dealer/investment banking activities priced in the market, under common ownership.
So you still have the advantages of, and the synergies, many of the synergies, of common ownership. But you have less of the intermingling that leads you to the conclusion that we can’t let them fail, we have to bail them out, because one part of it is in trouble, and the other part will become in trouble as well.
Let’s address that problem.
Washington Examiner: You haven’t heard much from industry, but what about from Congress? You think members are interested? Have you had buy-in?
Hoenig: Well, buy-in is a strong word. But I have had interest, in terms of what this proposal involves, whether it would solve some of those problems. There is a desire to end too-big-to-fail. And I think there is, not unanimous agreement, but at least a strong understanding that too-big-to-fail may not have been solved yet.
Washington Examiner: From both sides of the aisle?
Hoenig: From both sides of the aisle.
Washington Examiner: Care to name any names?
Hoenig: [Laughs.] No, I would not care to name any names.
Washington Examiner: When you put this out, a lot of people called it Glass-Steagall-light. Is that a fair characterization?
Hoenig: No, because Glass-Steagall is forcing complete divestiture of the institution. And that’s not what I’m proposing. What I’m proposing is to better identify the different activities, better price the risk of the different activities, and better separate the safety net in terms of its original purpose from how it’s been used to expand activities at lower cost, because it’s subsidized. So it’s to help contain the subsidy of the safety net.
Washington Examiner: It’s about aligning incentives. A lot of Glass-Steagall supporters would say it’s not just about the firm’s incentives, but also about the political incentives. And we want investment banks counter-lobbying against commercial banks, and insurers also a different interest. Do you share that view, is that a goal?
Hoenig: No, I mean I think everyone lobbies for their own interest. That’s not part of my goal. At all.
Washington Examiner: To get back to your point about capital: What I’ve heard, as a reporter, from the Obama administration, not so much from the Trump administration, and from the Federal Reserve, is that capital levels have doubled and the banking system is much safer. Do you agree with that? Is it where it needs to be?
Hoenig: I agree that the banking industry is better capitalized. It’s not adequately capitalized, no.
And here’s what I use as an example: In 2010, the year after the major disruptions, there were still, in terms of provisions for losses and losses, equal to 6 percent of the assets, tangible-wise, you know, real 6 percent. The banks had only 3 percent tangible equity entering into the last financial crisis but experienced losses of 6 percent.
Today the banks have about 6 percent tangible equity. That’s how much capital we have now, in the banks, on a tangible capital, loss-absorbing capital basis. If we had another crisis like the last one [6 percent of assets lost], that equity would still be wiped out. So you’re at zero today if we had a similar crisis, not negative 3 percent. That’s not negative, as it was in the last crisis, but it’s still zero.
No, we’re not adequately capitalized. We’re better capitalized. And doubling from a very small number is not a real big hurdle. I think the real hurdle is getting to what is adequate, which I judge as a minimum 10 percent tangible capital, leverage ratio, not risk-weighted.
And when we get there I’ll feel much better about the ability to withstand shock.
Here’s what I mean: If you think about it at today’s current level of tangible equity of 6 percent, [if] you have an individual bank fail, very large bank fail … you’re going to have repercussions across the economy and across other banks. That’s what happened last time.
Now, if you only have 3 or 4, or even 6 percent capital, and you have one major bank fail, every other major bank with only 6 percent tangible equity becomes suspect. Do you have really enough capital? Stakeholders may say that’s no more than the losses that we’re seeing in this one large bank, let’s run on the others, why take a chance? But if you have 10 or 12 percent, and you have a major bank failure, you say, “Well, it’s a failure, but the banks are much more strongly capitalized” and therefore they don’t run. And you don’t create a systemic crisis out of an individual bank crisis.
Washington Examiner: What do you mean by “tangible capital”?
Hoenig: Here’s what I mean: That you actually have an asset that has the value that can be sold if you have a crisis.
If you have a tax-deferred asset, what happens when the bank fails? It just disappears, because there’s no value. Goodwill is goodwill. And when things go bad, there’s no longer any goodwill. It’s all bad will, and people run. When you book goodwill that’s going to go away and you book a tax asset that’s definitely going to go away, there’s nothing to absorb loss. So what was reported as 7 percent was really 4 percent, and that’s all you have left to absorb …
Washington Examiner: Let me ask you about [Federal Reserve Bank of Minneapolis president] Neel Kashkari, a big advocate of higher capital levels. And he says pretty bluntly that all these mechanisms created to help banks fail — the debt shield, resolution authority — he just doesn’t believe in them. And he was there — he helped administer [the Troubled Asset Relief Program]. Do you agree with that?
Hoenig: I think he’s right on many fronts there, yes. I don’t know that I agree with everything he says, but I do think that there was nowhere near enough capital. I think the fact that we had to add capital, and everyone says we added capital only to the shadow banks, like the Bear Stearns, and AIG, but we added tons of capital to the banking industry. Citigroup is an obvious example, but to the banking industry more broadly.
We need to have a system where the bank stockholders absorb more loss, and that’s capital. When there’s enough capital there, those stockholders are much more attendant, and I think if you have a problem they will take a major part of the loss, the taxpayer is much better off in the end. And we have a stronger financial industry, so you don’t have the crisis in the first place that puts everyone out of work as quickly as it did last time.
So there’s many things we can do to strengthen the system.
Washington Examiner: Where will you be in the fall of 2018?
Hoenig: I don’t know, but I will say this: My job is vice chairman of the FDIC. That’s the only job I’m working for, and that’s the only job I’m going to do regardless of what the next job will be. I’m not planning for a next job. I’m working very hard being vice chair of the FDIC. That’s my job.
