Coverage: A proposal to end “too big to fail”

Neel Kashkari, the president of the Federal Reserve Bank of Minneapolis, proposed Wednesday phasing out the government’s designation of banks that are “too big to fail,” arguing that regulators need to be more aggressive in overseeing the financial institutions.

Michael Corkery of the New York Times has the news:

Mr. Kashkari’s proposal — called the Minneapolis Plan — would most likely pressure banks to break apart because the high cost of holding so much capital would mean it would no longer make sense to stay so large.

Such a breakup has not happened naturally since the financial crisis. While some big banks have gotten smaller, a great deal of lending and market-making activity is still concentrated in hands of a few Wall Street banks. And with that continued concentration comes risk of another bailout, he said.

By Mr. Kashkari’s calculation, the financial regulation since 2008 has reduced the chances of another government banking bailout to only 67 percent from 84 percent before the crisis.

His proposal would reduce that risk to 9 percent, he said, by requiring banks to hold much more capital than the current levels.

“I don’t want people to have a false sense of security that we have solved too-big-to-fail,” Mr. Kashkari said during the breakfast discussion on Wednesday.

Shayndi Rice and Adam Creighton of The Wall Street Journal note the proposal needs Congressional approval:

Mr. Kashkari’s proposal would require action by Congress. He said he doesn’t know what the chances are of lawmakers or the president-elect pushing legislation based on his plan.

Mr. Kashkari’s plan calls for banks with more than $250 billion in assets to hold common equity equivalent to 23.5% of risk-weighted assets. The equivalent leverage ratio would be 15%.

Those figures are multiples of current capital requirements and are aggressive when compared with other proposals aimed at raising such thresholds. But they are in line with a general push for new legislation sponsored by both Republicans and Democrats in Congress aimed at making the financial system safer by forcing banks to hold more capital.

The Financial Services Forum, a trade group representing the CEOs of the 16 largest financial institutions, released a statement criticizing Mr. Kashkari’s plan for its potential to hamper economic growth.

Adam Belz of the Minneapolis Star-Tribune reports that the plan would reduce another bailout to less than 10 percent in the next 100 years:

Kashkari acknowledged the plan comes at a price: Banks that hold more capital cannot lend as much. The Minneapolis Fed estimates the trade-off is worth it. A financial crisis typically exacts a permanent cost equal to the nation’s economic output for a year and a half, Kashkari said. The negative impact of higher capital requirements on banks would cost about 40 percent of economic output.

Americans must decide, Kashkari said, whether they are comfortable with the next financial crisis playing out like the last one.

“If you think once every 50 years is acceptable, fine, let’s stay the course,” he said. “I don’t think it’s acceptable. I think the devastation from the financial crisis, we’re still paying it, not just in terms of lost jobs and output. But I look at the polarization of the country today, and I feel like it is a direct outcome of the financial crisis. If we can avoid these types of scenarios, my gut tells me it’s worth paying some insurance for that.”

Kashkari was the Bush administration Treasury official in charge of the bailout in 2008. He saw it as a necessary evil, but one worth avoiding.