Building upon the Federal Reserve Bank of Minneapolis’ expertise in the area of Too Big to Fail (TBTF), President Neel Kashkari used his first public speech in February 2016 at the Brookings Institution in Washington, D.C., to launch an initiative aimed at addressing excessive risk posed by TBTF financial institutions.49 In his announcement, Kashkari committed to considering a broad range of policy solutions and putting forth a draft Minneapolis Plan by the end of 2016 for legislators, policymakers, and the public to consider.
The first phase of the initiative was rooted in hosting four policy symposiums based upon rigorous exploration and discourse, starting out with broad topics and then revisiting promising ideas with sharper analysis. From the outset, Kashkari pledged that the Ending TBTF initiative would be open and accessible to all. The dual goal of this transparent approach was to explore and analyze substantive solutions through the gathering of economists, policymakers, and other issue-area experts, while also educating the public about TBTF issues through open public forums. In this spirit of open and public discourse, all symposiums and public events within the Ending TBTF initiative were live-streamed and archived on the Minneapolis Fed website.50 The public has also been encouraged to interact by engaging through social media using the hashtag #EndingTBTF or submitting their input and ideas online.51
Upon publication of the draft Minneapolis Plan in November 2016, the second phase of the initiative commenced with a two-month public comment period that welcomed feedback and constructive input. The feedback received during this period became the basis of the response document that details the comments received and the revisions made to the November 2016 draft Plan. In addition to revising the draft Plan, the Minneapolis Fed continued its effort to educate the public about the continuing risk of Too Big to Fail through speaking engagements and written pieces published as traditional newspaper op-eds and online postings.
The first symposium focused on two specific transformational proposals for ending TBTF—higher capital requirements and limits on bank size—and featured a keynote address by a former Federal Reserve governor, who discussed the appropriate role of weighing both costs and benefits in financial regulation.52
The second symposium focused on two additional transformational proposals for ending TBTF—taxing bank debt and the new framework for resolving troubled institutions. The symposium also featured a keynote on the pros and cons of reinstituting the Glass-Steagall Act.58
Several participants noted the positive historical relationship between financial development and economic growth and questioned what effects high capital requirements would have on growth.
Co-hosted with the Peterson Institute for International Economics (PIIE), Washington, D.C.
The Ending TBTF initiative continued by gathering experts and policymakers at its third in a series of policy symposiums and the first with a co-host, PIIE in Washington, D.C.66 The third symposium took a deeper dive into the benefits and costs of higher bank capital requirements. This gathering also had a session assessing the current status of the Ending TBTF initiative, including a keynote from Minneapolis Fed President Neel Kashkari.
The panelists raised a number of arguments with regard to assessing the benefits and costs of higher capital requirements. Their range of views also suggested several lessons for any exercise in trying to review the benefits and costs of higher capital. Key points from that session along both of those lines included but were not limited to the following:
Minneapolis Fed President Neel Kashkari opened with his remarks on the status of ending TBTF. Bertrand Badre, formerly group chief financial officer at Société Générale and Crédit Agricole, provided a private sector perspective. PIIE President Adam S. Posen assessed the global TBTF regime and international regulatory efforts. The presenters offered mostly common themes with the occasional contrasting views.
The fourth and final symposium hosted by the Federal Reserve Bank of Minneapolis was held on September 26, 2016. Progressing toward the goal of releasing a policy plan to end too big to fail (TBTF) by the end of the year, the symposium explored additional challenges and solutions to the persistent problem of TBTF.
Two panel discussions were held, the first focusing on whether debt issued by banks—such as “bail in” bonds required under a current Board of Governors proposal—can effectively recapitalize banks in the resolution process. The second panel discussed the growth of the shadow banking industry in response to the asymmetrical regulatory framework of banks and nonbanks.
This fourth symposium also featured a keynote speech by Roger W. Ferguson, Jr., who shared views on financial regulation based on both his current role as president and CEO of TIAA and his prior role as governor and vice chair of the Board of Governors of the Federal Reserve System.
The Federal Reserve Bank of Minneapolis has engaged throughout 2016 in a public process to determine the best ways to end the problem of too big to fail banks. We solicited feedback throughout the year, held town halls with the public and held four policy symposiums, which brought together experts with a wide range of perspectives on the problem and on potential solutions. The symposiums were streamed live on the web to allow the public to learn alongside the Minneapolis Fed. Video recordings and all presented materials are available on our website at minneapolisfed.org. Input from the public and experts around the world have shaped our effort.
Today, November 16, we released our proposal to end TBTF: the Minneapolis Plan. And as a continuation of our effort to both inform and learn from the public and experts, we continue to seek input. Specifically, the Federal Reserve Bank of Minneapolis seeks comments on its proposal to end TBTF.
Commenters should provide feedback by January 17, 2017, sixty days after the issuance of the proposal. Comments should be submitted via www.minneapolisfed.org/MPLSplancomments. Specific comments will not be made public, but the Minneapolis Fed will publish an aggregated summary of the comments when a revised version of the proposal is released.
The Federal Reserve Bank of Minneapolis welcomes feedback on all aspects of the Minneapolis Plan. Commenters can also provide feedback on the following specific questions:
- Benefit and Cost Analysis of Higher Minimum Equity Requirement
The Minneapolis Plan would increase the minimum equity requirement for banks with assets over $250 billion, reflecting an underlying analysis of the benefits and costs of higher capital.
(Q1) Are there improvements that the Federal Reserve Bank of Minneapolis could make to its calculation of the benefits of this aspect of the proposal?
(Q2) Are there improvements that the Federal Reserve Bank of Minneapolis could make to its calculation of the costs of this aspect of the proposal?
(Q3) Are there improvements that the Federal Reserve Bank of Minneapolis could make to its proposed minimum equity requirement for large banks?
- Benefit and Cost Analysis of a “Systemic Risk Capital Charge”
The proposal would create a Systemic Risk Capital Charge for all firms that the Treasury Secretary fails to certify as no longer systemically important.
(Q4) Are there improvements that the Federal Reserve Bank of Minneapolis could make to its calculation of the benefits of this aspect of the proposal?
(Q5) Are there improvements that the Federal Reserve Bank of Minneapolis could make to its calculation of the costs of this aspect of the proposal?
(Q6) Are there improvements that the Federal Reserve Bank of Minneapolis could make to its proposal calling on the Treasury Secretary to certify that firms are no longer systemically important?
(Q7) Are there alternative frameworks the Federal Reserve Bank of Minneapolis could use in reducing systemic risk of large financial firms?
- Setting a Shadow Banking Tax
The proposal would levy a tax on shadow banks.
(Q8) Are there improvements that the Federal Reserve Bank of Minneapolis could make to setting a tax on shadow banks within the framework set forth in the proposal?
(Q9) Are there alternative frameworks the Federal Reserve Bank of Minneapolis could use in setting a tax on shadow banks? What are they? How would a fee be calculated using these alternative frameworks? Why are they superior to the framework used in the proposal?
- Right Sizing Community Bank Supervision and Regulation
The proposal would create a separate and more appropriate supervisory and regulatory regime for community banks.
(Q10) Are there specific features of such a regime that the current proposal should include but does not?
(Q11) Are there specific features of such a regime that the current proposal includes that it should not?
Wall Street Journal Op-Ed, February 14, 2017
Make Big Banks Put 20% Down—Just Like Home Buyers Do
Financial CEOs say capital requirements are already too high, but the facts suggest otherwise.
By Neel Kashkari
There’s a straightforward way to help prevent the next financial crisis, fix the too-big-to-fail problem, and still relax regulations on community lenders: increase capital requirements for the largest banks. In November, the Federal Reserve Bank of Minneapolis, which I lead, announced a draft proposal to do precisely that. Our Plan would increase capital requirements on the biggest banks—those with assets over $250 billion—to at least 23.5%. It would reduce the risk of a taxpayer bailout to less than 10% over the next century.
Alarmingly, there has been recent public discussion of moving in the opposite direction. Several large-bank CEOs have suggested that their capital requirements are already too high and are holding back lending. As this newspaper reported, Bank of America CEO Brian Moynihan recently asked, “Do we have [to hold] an extra $20 billion in capital? Which doesn’t sound like a lot, but that’s $200 billion in loans we could make.”
It is true that some regulations implemented after the 2008 financial crisis are imposing undue burdens, especially on small banks, without actually making the financial system safer. But the assertion that capital requirements are holding back lending is demonstrably false.
How can I prove it? Simple: Borrowing costs for homeowners and businesses are near record lows. If loans were scarce, borrowers would be competing for them, driving up costs. That isn’t happening. Nor do other indicators suggest a lack of loans. Bank credit has grown 23% over the past three years, about twice as much as nominal gross domestic product. Only 4% of small businesses surveyed by the National Federation of Independent Business report not having their credit needs met.
If capital standards are relaxed, banks will almost certainly use the newly freed money to buy back their stock and increase dividends. The goal for large banks won’t be to increase lending, but to boost their stock prices. Let’s not forget: That’s the job of a bank CEO. It isn’t to protect taxpayers.
So if capital requirements aren’t the problem, why does it feel so hard to get a loan today? I can speak from firsthand experience. Last year my wife and I decided to buy a house. We applied for a loan with a bank where I have been a customer for many years. I assumed that my long record with the bank and our good credit would make it easy. With the required 20% down payment, we were prequalified for a mortgage with a rate of 3.375% fixed for the first 10 years. That was an attractive rate, suggesting capital was not holding back lending.
The prequalification was easy. Then the frustration began. The mortgage banker asked for myriad documents: bank statements, 401(k) statements, brokerage statements, tax returns, W-2s, insurance records and so on. That all seemed reasonable, but as the weeks rolled on, the requests for more documentation kept coming. After a month or so, I couldn’t believe what I was being asked for. Despite having all the records of my on-time monthly rental payments in my checking account, the bank demanded a copy of my lease and to speak with my landlord.
The banker called me to apologize, admitting that the requests were ridiculous but saying that there was no reasoning with the underwriting department. As we waited, we began to wonder if we wanted to buy the house at all. Wouldn’t continuing to rent be so much easier?
In the end, the bank funded the loan. I felt bad for the underwriters, who seemed unable to exercise judgment or use common sense. The impression I got was that people at the bank were simply paralyzed by fear—that they might make a mistake that regulators would be breathing down their necks.
I have spoken to many borrowers at other banks, and they tell me similar stories. It has become needlessly difficult for qualified borrowers to get loans. But again, the problem isn’t the capital requirements—it’s everything else.
Capital is the best defense against bailouts. Although capital standards are higher than before the last crisis, they are not nearly high enough. The odds of a bailout in the next century are still nearly 70%. Large banks need to be able to withstand around a 20% loss on their assets to protect against taxpayer bailouts in a downturn like the Great Recession, according to a 2015 analysis by the Federal Reserve. Unfortunately, regulators have taken it easy on the large banks, which today have only about half of the equity they need.
There is a simple and fair solution to the too-big-to-fail problem. Banks ask us to put 20% down when buying our homes to protect them in case we run into trouble. Similarly, taxpayers should make large banks put 20% down in the form of equity to prevent bailouts in case the financial system runs into trouble. Higher capital for large banks and streamlined regulation for small banks would minimize frustration for borrowers. If 20% down is reasonable to ask of us, it is reasonable to ask of the banks.
Mr. Kashkari is president of the Federal Reserve Bank of Minneapolis and a participant in the Federal Open Market Committee.
Medium post, April 4, 2017
Jamie Dimon’s Shareholder (Advocacy) Letter
By Neel Kashkari
On April 4, JPMorgan Chase Chairman and CEO Jamie Dimon published his annual shareholder letter, much of which focused on public policy and financial regulation. At 46 pages, Mr. Dimon’s letter includes a lot of interesting commentary. In this essay, I am going to respond to two of his main points because I strongly disagree with them. First, Mr. Dimon asserts that “essentially, Too Big to Fail has been solved — taxpayers will not pay if a bank fails.” Second, Mr. Dimon asserts that “it is clear that the banks have too much capital.” Both of these assertions are demonstrably false.
Too big to fail has not been solved
To make his argument that TBTF has been solved, Mr. Dimon repeatedly points to various regulatory schemes that all have the same unrealistic feature: In a crisis, bondholders will take losses rather than taxpayers. He refers to “bail-inable debt,” “total loss absorbing capacity,” “receivership where unsecured debt … would convert to equity,” “Chapter 14 bankruptcy” and “resolution.” All of these essentially mean the same thing: A bank runs into trouble; then either regulators or the courts trigger a conversion of debt to equity. Bondholders take losses. The firm is recapitalized and taxpayers are spared. Systemic risk is neutralized and bailouts are avoided. It sounds like an ideal solution. The problem is that it almost never actually works in real life.
We learned from past financial crises, including the 2008 financial crisis, that nothing beats equity for absorbing losses. Equity holders have long taken losses in the United States and thus expect that outcome. Moreover, equity holders cannot run during a crisis. In contrast, debt holders of the most systemically important banks in the United States and around the world have repeatedly experienced bailouts and likely will expect such an outcome during the next financial crisis. Indeed, the most recent crisis showed that even some debt holders who had been explicitly told that they would take losses during a crisis got bailed out.
Governments are reluctant to impose losses on creditors of a TBTF bank during a crisis because of the risk of contagion: Creditors at other TBTF banks may fear they will face similar losses and will then try to pull whatever funding they can, or at least refuse to reinvest when debt comes due. This is why, regardless of their promises during good times, governments do not want to impose losses on bondholders during a crisis. History has repeatedly shown this to be true and, while we can hope for the best, there is no credible reason to believe this won’t be true in the next crisis. Only true equity should be considered loss-absorbing in a crisis. The largest banks do not have enough equity today to protect taxpayers. Too big to fail is alive and well. Taxpayers are on the hook.
Large banks have too little capital, not too much
To make his argument that banks have too much capital, Mr. Dimon points to losses estimated by the Federal Reserve’s stress test and compares them to banks’ combined equity and long-term debt. Again, Mr. Dimon unrealistically assumes that debt will absorb losses in a crisis. As explained above, that is extremely unlikely. In addition, stress tests are just hypothetical scenarios. By definition, regulators (and bankers) won’t see the next crisis coming, and it will almost certainly look different from past crises, or scenarios modeled in a stress test.
Mr. Dimon argues that the current capital standards are restraining lending and impairing economic growth, yet he also points out that JPMorgan bought back $26 billion in stock over the past five years. If JPMorgan really had demand for additional loans from creditworthy borrowers, why did it turn those customers away and instead choose to buy back its stock?
The truth is that borrowing costs for homeowners and businesses are near record lows. If loans were scarce, borrowers would be competing for them, driving up costs. That isn’t happening. Nor do other indicators suggest a lack of loans. Bank credit has grown 23 percent over the past three years, about twice as much as nominal gross domestic product. Only 4 percent of small businesses surveyed by the National Federation of Independent Business report not having their credit needs met.
Capital is the best defense against bailouts. Although capital standards are higher than before the last crisis, they are not nearly high enough. The odds of a bailout in the next century are still nearly 70 percent. Large banks need to be able to withstand around a 20 percent loss on their assets to protect against taxpayer bailouts in a downturn like the Great Recession, according to a 2015 analysis by the Federal Reserve. Unfortunately, regulators have taken it easy on the large banks, which today have only about half of the equity they need.
Doubling the equity capital requirements for the largest banks would substantially address the TBTF problem and protect taxpayers. It also passes a cost-benefit test for society.
Areas of agreement
Mr. Dimon calls for reducing regulatory complexity, and I agree with this principle. In fact, a higher equity requirement produces the most protection for taxpayers in the simplest, most effective way. Once we have addressed TBTF by forcing large banks to fund themselves with far more common equity, I believe we can streamline other regulations, especially on small banks that have been severely burdened with regulation, but do not pose a systemic risk to society.
Wall Street Journal Op-Ed, July 9, 2017
New Bailouts Prove ‘Too Big to Fail’ Is Alive and Well
Regulators keep insisting bondholders will take losses, but then they’re reluctant to impose them.
By Neel Kashkari
Three strikeouts in four at bats would be barely acceptable in baseball. For a policy designed to prevent taxpayer bailouts, it’s an undeniable defeat. In the past few weeks, four European bank failures have demonstrated that a signature feature of the postcrisis regulatory regime simply cannot protect the public. There’s no need for more evidence: “bail-in debt” doesn’t prevent bailouts. It’s time to admit this and move to a simpler solution that will work: more common equity.
Bail-in debt was envisioned as an elegant solution to the “too big to fail” problem. When a bank ran into trouble, regulators could trigger a conversion of debt to equity. Bondholders would take the losses. The firm would be recapitalized. Taxpayers would be spared.
The idea, adopted both in the U.S. and Europe following the 2008 financial crisis, has its share of supporters, including JPMorgan Chase CEO James Dimon. “Essentially, too big to fail has been solved,” Mr. Dimon insisted in a shareholder letter earlier this year. “Taxpayers will not pay if a bank fails.” Wall Street also prefers this debt funding rather than equity because it is better for bank share prices. In theory, taxpayers and stockholders both win.
The problem is that it rarely works this way in real life. On June 1, the Italian government and European Union agreed to bail out Banca Monte dei Paschi di Siena with a €6.6 billion infusion, while protecting some bondholders who should have taken losses. Then on June 24, Italy decided to use public funds to protect bondholders of two more banks, Banca Popolare di Vicenza and Veneto Banca, with up to €17 billion of capital and guarantees. The one recent case in which taxpayers were spared was in Spain, when Banco Popular failed on June 6.
The largest of these four banks was less than one-tenth the size of $2.5 trillion JPMorgan. Think about that: If bail-in debt couldn’t protect taxpayers from a midsize bank failure when the global economy is stable, what are the odds it will work if a Wall Street giant runs into trouble when the economy looks shaky? Or how about when several giants are in trouble at the same time, as in 2008? Don’t hold your breath.
Why are governments so reluctant to force losses on bondholders? Sometimes they fear financial contagion. The argument holds water in the case of too-big-to-fail banks: If creditors at one large institution face losses, creditors at others may fear the same and try to pull their funding. Once the dominoes start falling, they are very hard to stop. This is why the Federal Reserve and the Treasury Department, with the support of Congress through the Troubled Asset Relief Program, intervened so dramatically to arrest the 2008 crisis.
When systemic risk isn’t an issue, governments may worry that bondholders are politically important constituents. In the recent Italian examples, the banks weren’t considered too big to fail, but the bondholders were retail investors. Regulators claimed that this was a unique circumstance, but there always seem to be unique circumstances when bailouts are concerned. What will happen if an important pension fund faces losses?
This is one more reminder that only equity can be counted on to protect taxpayers—and it needs to be raised in advance of economic distress. Although capital standards for America’s largest banks are higher now than before the last crisis, they are not nearly high enough. The odds of a bailout in the next century are still nearly 70%.
Large banks need to be able to withstand losses of around 20%, according to a 2015 analysis by the Federal Reserve. But they have only about half that amount in equity because regulators have generously assumed bondholders would take losses. Italy demonstrates that this is wishful thinking. Too big to fail is alive and well, and taxpayers are on the hook.
There is bipartisan support for fixing the problem, but it will require forcing large banks to raise much more equity. They won’t do it on their own, because their stock prices benefit when the public takes the risk. Indeed, banks are now moving in the wrong direction by increasing their dividends and stock buybacks. As a country, we must decide what’s more important: protecting taxpayers or bank investors.
Mr. Kashkari is president of the Federal Reserve Bank of Minneapolis and a member of the Federal Open Market Committee.
Public Town Hall, April 4, 2016
Immediately following the first policy symposium, a public Town Hall meeting on ending TBTF was hosted at the Minneapolis Fed.71 Attendance was open and free to the public.
Public Update to Minnesota Chamber of Commerce, April 18, 2016
Kashkari shared a public update on the Ending TBTF initiative by summarizing key points that he took away from the April 4 symposium.72 He also identified some important questions for further consideration:
- Should we view proposals to address TBTF in isolation, or could we combine them?
- How do the costs and benefits of proposed solutions line up relative to the status quo?
- How much confidence do we have that the solutions will perform as expected in a crisis environment?
- Will markets think the proposal credibly puts creditors at risk of loss?
- Will the solutions merely push risk into unregulated areas of the financial markets?
- Will the solutions promote fairness between the regulatory burdens imposed upon large, medium and small banks?
- How likely are the solutions to remain effective over decades?
Public Evening Discussion, May 16, 2016
Following the second policy symposium held at the Minneapolis Fed, an evening discussion was hosted by the Heller-Hurwicz Economics Institute at the University of Minnesota and moderated by CNBC’s chief Washington correspondent, John Harwood.73 This event was also open and free to the public.
Panelist on Ending “Too Big to Fail” Banks Discussion at the American Economic Association Conference, January 7, 2017
President Neel Kashkari participated in a panel discussion74 where he presented the primary elements of the draft Minneapolis Plan and received feedback from Randall S. Kroszner of the University of Chicago and Markus K. Brunnermeier of Princeton University. Wayne Passmore of the Federal Reserve System Board of Governors served as panel chair.
Presentation of the Draft Minneapolis Plan to the National Association of Business Economics, March 6, 2017
In an effort to share the draft Minneapolis Plan with a variety of interested audiences and to invite feedback on the Plan, President Neel Kashkari presented a set of summary slides75 to the National Association of Business Economics.
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