Kansas City, Kansas City Here I Come - Fed President Hoenig Speech

The Kansas City Federal Reserve President, Thomas Hoenig, spoke truth to power in a speech to the U.S. Chamber of Commerce, titled The Financial Foundation for Main Street. This is how it starts out:

If we stray from our core principles of fairness or ignore the rule of law, we distort the playing field and inevitably cultivate a crisis. When the markets are no longer competitive, firms become a monopoly or an oligopoly and it matters more who you know than what you know.

Then, the economy loses its ability to innovate and succeed. When the market perceives an unfair advantage of some over others, the very foundation of the economic system is compromised.

In these instances, for example, bonuses will far exceed the economic value provided, because the bonus is what we economists call an economic rent. It is not earned, it is only received. The protected will act as if they are protected, they will retain their status independent of performance, and the public will suffer. I like to say, “If you give someone a monopoly, they will act like a monopolist every time.”

Wow. The speech continues with a glorified slam on current reforms passed and on the Senate floor currently:

While calling for action myself, I have been uneasy with what I have seen so far. The attempts to address capital markets and their role as the “Financial Foundation for Main Street,” appear to place a much higher value on rhetoric than on substance and necessary reform.

Hoenig continues to say the real problem are some institutions are simply too big and their unbridled power literally guarantees they will be bailed out.

Hoenig then outlines 3 financial reform recommendations:

We must have a credible resolution process that forces shareholders, responsible senior management, and creditors to incur loss if the company takes on excessive risk and becomes insolvent. To be credible, the resolution regime must be independent of the political process and based on the rule of law. Only then, will creditors force these firms to operate with lower leverage. The current legislation in both houses of Congress begins to address this issue. Unfortunately, both still leave considerable room for exception in the hands of the Treasury.

Hoenig makes no bones on TBTF. If a financial institution is too big to fail, then it is too big to exist. This is Senator Bernie Sanders legislation, which of course is being ignored to date.

Second, we must strengthen our supervision of financial firms by returning to simple, well-established rules, such as maximum leverage and loan-to-value ratios.

Third, we must improve the regulatory framework, which may involve reversing some of the deregulation that occurred in the 1990s. Specifically, adopting a version of the proposed Volcker rule would be healthy for long-term stability. It should (1) focus on banning financial holding companies from proprietary trading and investing in or sponsoring hedge funds, and (2) require trading and private equity investment to be housed in separately capitalized subsidiaries subject to strict leverage and concentration limitations.

There it is, a glorified reinstate Glass-Steagall, which is similar to the Volcker Rule.

Hoenig also says this on derivatives:

Requiring standardized derivative transactions to be cleared through centralized counterparties, and to the extent feasible, traded on exchanges.

Note the keyword standardized. I will assume this means derivatives must be approved before being allowed on the market.

Why isn't this guy running the Federal Reserve? At least the Kansas City Fed has some common sense, shame it's not in D.C.

On the Kansas City Fed website are a collection of papers which go into more details on financial reform recommendations. I would also recommend reading the entire speech, it's obviously a good one!

Bloomberg notes that the Kansas City Fed does not oversee any banks with greater than $50 billion in assets.

Currently the Senate Financial Reform bill removes financial holding companies with less than $50 billion from Federal Reserve oversight.

More later on what this implies but it doesn't seem quite right to put the TBTF in one category and everyone else in another, one run by the FDIC and another the Federal Reserve, just in terms of access to power and influence. Anyone recall Separate but Equal?

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