A Federal Reserve official on Wednesday outlined a plan for ending the problem of “too-big-to-fail” banks by massively raising their capital requirements and imposing taxes on debt at non-banks, a strategy that is not likely to become law now but could provide a blueprint for reforming Wall Street in the future.
Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, unveiled the highly-anticipated plan at an event in New York City, said that if the plan “prevents one financial crisis, it will have paid for itself multiple times over.”
Kashkari’s plan, the result of months of research and public consultation, is meant to go beyond the current Dodd-Frank regulatory regime.
The centerpiece of the plan is a requirement that big banks maintain a capital level of 23.5 percent of assets, adjusting for the riskiness of the specific assets the banks hold. That is a mandate that the banks rely more on ownership stakes and less on borrowing to fund their activities. Today, the biggest banks face a comparable requirement of under 10 percent.
Under Kashkari’s plan, the Treasury secretary would be required to certify that big banks were not too big to fail. If he or she did not, the capital level would go up, all the way to 38 percent. The point of that step would be to effectively force the bank to break itself up.
Large non-bank financial companies, such as mutual funds, would face a tax on debt in order to prevent risk from shifting to those “shadow banks,” as has been the trend.
Community banks would be deregulated in the hopes of fostering a system in which the big banks were smaller, and these smaller, better capitalized banks would play a bigger role in the economy.
Kashkari made the case for the plan on the grounds that financial crises are usually extremely costly — one estimate says the average one costs a country between one and two years’ worth of economic output. He added that another cost of the most recent crises, beyond the financial setbacks, has been the subsequent polarization of the country and political turmoil.
“It’s worth it to pay some insurance for that,” he said.
He also dismissed the regime put in place by regulators to facilitate an orderly resolution of a big bank in a crisis. Those schemes include regular stress tests, forcing banks to issue “living wills” that spell how they could be resolved, and a requirement that banks specify ahead of time which bondholders would be the first to take losses.
Kashkari called those ideas a “Rube Goldberg machine” and a “farce.”
He compared relying on those mechanisms in the chaos of a crisis to Chesley “Sully” Sullenberger landing his plane in the Hudson River — while also consulting a thousand-page document. “It’s anybody’s guess how this is going to work in a crisis,” he said.
Kashkari cited his own experience directing the TARP bailouts of banks in 2008 as a member of George W. Bush’s Treasury. That background, along with his experience as a banker at Goldman Sachs, made it a surprise when he launched the initiative to address too-big-to-fail.
