The Federal Reserve Bank of Minneapolis next week will have its second symposium on what to do about the risk of having to bail out a bank that is still too big to fail. But we already know representatives of the biggest banks will skip this one, the same way they did the first.
Minneapolis Fed President Neel Kashkari, who is making “too big to fail” his signature issue, said he called and e-mailed all the big banks after the first symposium, pointing out that every effort was made to be balanced. And they have declined to participate.
“That’s fine,” he added. “We’re having the conversation without them.”
Kashkari said he can understand the bankers’ disagreeing with him, but he is surprised “they are as angry as they are.
“My best guess at how this would have gone is that this would be a splash for a few days, and then everyone would try to ignore us. But the fact of the matter is, they are trying to throw every criticism at us.”
What they aren’t doing is talking with him about the problem, although there’s an undeniable logic to staying away from any public forum discussing a policy problem when it’s your position that no such problem even exists.
Still it would be far better to have the banks working with Kashkari to shape the policy proposal he intends to issue from the Minneapolis Fed. If Kashkari is wrong, here’s a chance to show us.
Kashkari did manage to make a splash, with words like “radical” appearing in the headlines following a speech he gave in Washington in February. And the bankers’ trade associations will explain — off the record — that the way he’s gone about this is a big part of their distrust of him.
A typically wonky Fed president talking about the weaknesses of the Dodd-Frank financial reform law wouldn’t have likened a big bank that gets out of control to a nuclear reactor that melts down, as Kashkari did.
A typical Fed president wouldn’t have put the kind of options Kashkari did on the table, either, including busting up the biggest banks or basically turning them into utilities.
“I knew what I was doing,” he said, of the ruckus he caused. “I knew my first speech was going to get a lot of attention, just because it was my first speech. I had a choice. I could have given [an] economic outlook, and everybody would yawn. Or we could use it to actually advance a public policy mission.”
His goal remains to spark a national conversation about the continuing risk of having banks that are too big to fail. And to his credit, he realized that a cautious approach from a regional Fed bank president doesn’t usually start one of those.
As a Treasury official in 2008 and 2009, Kashkari learned firsthand about the problem of having financial companies so big and important to the financial system that the taxpayer couldn’t let them go bust, at least not without risking a cascade of losses and the spread of panic that would eventually take down the broader economy.
He said he didn’t come to Minneapolis simply to tackle that problem. There isn’t even a “global systemically important bank” in his Fed district.
Rather, he said, he just wanted to make sure the Minneapolis Fed took the lead on a challenging economic or regulatory problem. His plans on “too big to fail” banks only took shape after he got the job and came to Minneapolis late last year to meet with senior Fed staff, who turned out to share his concerns.
The timing seems right now too, he said. It made sense to put off sweeping reforms just after the 2008-2009 crisis when the economy was still very fragile, but we also can’t wait much longer. Memories will soon fade of what the fall of 2008 felt like, with a fear in the credit markets so widespread that investors were pulling money out of money market funds and blue-chip companies couldn’t refinance their short-term commercial paper.
It was also a relief to hear him acknowledge that the right thing to do might be nothing, as the alternatives to the current structure of the financial system could all prove to be too costly.
“If critics say that Kashkari has made up his mind that banks are still too big to fail, then you’re right,” he said. “Guilty. What I have not made up my mind on is what the solution is.”
Getting criticized as a publicity hound and political opportunist has, in a curious way, convinced him he is on the right track, although this sounds a little unconvincing, kind of like a boy in the sixth grade buying his mom’s explanation that he’s getting picked on by the girls because they actually like him.
“This is what’s so interesting about this,” he said. “They can’t debate it on the merits, so they are reduced to trying to disqualify the process or disqualify me as the messenger. The initial arguments were ‘Oh he’s so political.’ I don’t even know what that means.”
He has kept up his talk about the issue, including last month before the Minnesota Chamber of Commerce. He talked then about one of the more obscure ideas to get big banks through the next crisis without a bailout, a kind of bank-issued bond called a contingent-convertible.
Convertible bonds have been around for generations, but these so-called CoCo bonds are oddballs. They are bonds that get turned into stock when a bank runs into trouble. That sounds great, with money being kept in the bank to cushion losses rather than have it go out the door to pay off bondholders.
In practice, these kinds of bonds haven’t worked out so well, Kashkari explained to the chamber. They have the effect of spreading uncertainty from one bank to another, such as when bondholders of Acme Bank panic once they see the bondholders of the Ajax National Bank get forced into being owners.
They are also very costly, because bond investors figured out that banks will have to pay them a lot to accept the risks of ownership.
In short, he argued, the CoCo bonds are a nifty-sounding idea that won’t work.
“You know what I’ve heard in response?” Kashkari asked. “Silence. Not a peep. If [the banks] had any substantive arguments for why my analysis was wrong, they would be shouting it. But it’s been complete and utter silence. Because they know I’m right.”