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Hoenig: Big banks are fundamentally inconsistent with capitalism

Much of the Dodd-Frank discussion revolves around the economic distortions and disruptions caused by the largest and most complex financial companies, the so-called systemically important financial institutions, or SIFIs.

As we consider the topic of SIFIs, let me ask the following questions: How can one firm of relatively small global significance merit a government bailout? How can a single investment bank on Wall Street bring the world to the brink of financial collapse? How can a single insurance company require billions of dollars of public funds to stay solvent and yet continue to operate as a private institution? How can a relatively small country such as Greece hold Europe financially hostage? These are the questions for which I have found no satisfactory answers. That’s because there are none. It is not acceptable to say that these events occurred because they involved systemically important financial institutions.

Because there are no satisfactory answers to these questions, I suggest that the problem with SIFIs is they are fundamentally inconsistent with capitalism. They are inherently destabilizing to global markets and detrimental to world growth. So long as the concept of a SIFI exists, and there are institutions so powerful and considered so important that they require special support and different rules, he future of capitalism is at risk and our market economy is in peril.

-Thomas Hoenig, Pew Financial Reform Project and New York University Stern School of Business, 27 June 2011

Hoenig, like many Fed leaders from the Reserve banks outside of Washington and the money centers in New York, Boston and San Francisco, is more comfortable with safe and boring banking than the higher risk model that brought the global economy to its knees. Hoenig recommends re-imposing Glass-Steagall but allowing banks to engage in underwriting securities and advisory services, and asset and wealth management services as well. This is an important speech criticising the status quo in money, banking and politics from one of America’s most respected regulators. I have embedded a copy of the full piece below.

About 

Edward Harrison is the founder of Credit Writedowns and a former career diplomat, investment banker and technology executive with over twenty years of business experience. He is also a regular economic and financial commentator on BBC World News, CNBC Television, Business News Network, CBC, Fox Television and RT Television. He speaks six languages and reads another five, skills he uses to provide a more global perspective. Edward holds an MBA in Finance from Columbia University and a BA in Economics from Dartmouth College. Edward also writes a premium financial newsletter. Sign up here for a free trial.

7 Comments

  1. David Lazarus says:

    There is some merit with banks being allowed asset and wealth management as long as they do not operate on their own account. The risks would be the clients and not the banks. Underwriting is one area that could be problematic. Advisory also depends on its scope. Screwing up a underwriting or advisory event could cost billions. The scope of any reform should be to eliminate systemic weakness of the system, and that means first splitting the investment banks from the banks and then looking at shrinking the banks.

  2. Hilary Barnes says:

    The democratic system of government itself also needs to defend itself against these monsters. Capitalism (well regulated) and democracy go hand in hand.

    • David Lazarus says:

      Yes but in the US it is hardly regulated and you really only have policies of the rich being adopted. I do think that capaitlism has significant benefits over any other system, but it does need to be regulated otherewise you enslave the population under corporations rather the governments. As an ordinary person you have no power over corporations. You can at least vote out a government.

  3. fresno dan says:

    “As we consider the topic of SIFIs, let me ask the following questions: … How can a single insurance company require billions of dollars of public funds to stay solvent and yet continue to operate as a private institution? …. These are the questions for which I have found no satisfactory answers. That’s because there are none.”

    If you have institution A hedging 50% of the assets of institution B, and institution B hedging 50% of the assets of institution C, which hedges 50% of the assets of institution A….
    Of course, the question I would ask is, “Why can’t we let companies…I mean, ginormous financial institutions that make foolish financial bets, FAIL? Oh yeah, they’re ginormous…

    • David Lazarus says:

      AIG made itself too important to fail because without it most of the worlds airlines would not have been covered by any insurance. The solution is to break the insurance companies up. Financial insurance is not the same as the actuarial risk of a plane crash. In some cases they actively want failure, like Goldman Sachs creation of MBS which had no chance. It would be like allowing Al Qaedas to insure flights against suicide bomber incidents. So if they succeeded then Al Qaeda would have benefited financially from an event like 9/11!

  4. nick gogerty says:

    like liberty the right to pursue wealth should end at the borders of potential harm to others. Systemic significance is such a boundary where ones actions and the consequences of them are no longer limited to the individual may alter the group.

    Good systems are robust due to decentralization and low concentration risk. Here is a brief 3 slide powerpoint illustrating the point and why sifi’s are always systemically dangerous a la the Gresham process.

    The trade off is between efficiency (high ROE) and safety(long term stability).

    http://www.slideshare.net/ngogerty/banking-failure-by-design-and-dynamic