December 4, 2021

Today’s Economist: Simon Johnson: Sheila Bair Could Fill a Fed Vacuum in Bank Supervision


Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz Professor of Entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

President Obama should nominate Sheila Bair as vice chairwoman for supervision at the Federal Reserve. This position was created by the Dodd-Frank financial reform legislation (Section 1108 in Title XI) but has gone unfilled for nearly three years – clearly not in line with the intentions of legislators, who even specified that this official should testify before Congress on a semiannual basis.

Today’s Economist

Perspectives from expert contributors.

Ms. Bair is an experienced regulator, the former chairwoman of the Federal Deposit Insurance Corporation and the author of “Bull by the Horns,” an excellent book on what went wrong with the financial system and how to fix it. She currently works as an effective advocate for financial reform as a senior adviser at the Pew Charitable Trusts, and she founded and is chairwoman of the Systemic Risk Council (I am a member of this council).

No one has stronger bipartisan support and a better working relationship with reasonable people across Washington. There is now a potential vacancy on the Fed board, as Elizabeth Duke’s term as governor expired more than a year ago; she continues to serve until a successor is appointed. The reformist wing at the Fed desperately needs serious reinforcement.

And the Federal Reserve itself faces a broader impending crisis of legitimacy if it fails to decisively confront the problem of too big to fail. Anyone who believes in the importance of an independent central bank should work hard to force the Fed to act decisively on big banks.

Since the fall, Daniel Tarullo, an academic expert on banking and currently the lead Fed governor for financial regulation, has given some encouraging speeches, including a discussion of the need to impose effective size caps on the largest banks. He is also known to be in favor of stronger capital requirements than some of his Fed colleagues. And he is much more likely to push for bank holding companies to finance themselves with enough equity and long-term subordinated debt to serve as a loss-absorber in the case of financial failure.

But Mr. Tarullo has not yet made much discernible progress – and there is a real danger that the Fed will slip into a wait-and-see policy that will lead nowhere.

When questioned by Senator Elizabeth Warren, Democrat of Massachusetts, in a recent hearing, Ben Bernanke, the Fed chairman, was vague and unconvincing on the importance of additional measures to reduce the dangers posed by “too big to fail” banks.

And I was further discouraged on Monday by the wording of a speech by Jerome Powell, a relatively new member of the Fed’s Board of Governors. Mr. Powell’s line is that while “success is not assured” for existing measures that aim to end “too big to fail,” we should merely study additional steps (such as size caps; see Pages 12-13 of his speech).

Mr. Powell did not deny the existence of too-big-to-fail subsidies – and this puts important distance between his views and those expressed, for example, by people at JPMorgan Chase. But he did not suggest that the Fed should measure the subsidies these institutions receive – or the dangers that they pose. In effect he and his colleagues are saying, “Trust us, and we’ll continue to provide you with vague answers and promises of future progress.”

There is a more general level of vagueness in Mr. Powell’s speech that is deeply disconcerting (and I felt the same way about Mr. Bernanke’s exchange with Senator Warren). When will the Fed board decide that the “too big to fail” reform project is insufficient and on what basis? It’s already nearly three years since the passage of Dodd-Frank, yet the implicit subsidies and general unfair competitive advantages of megabanks show no signs of receding.

Will the “living will” process – in which banks are supposed to present plans for their own demise in the event of big losses – be used to bring effective pressure to bear on the big banks, as Thomas Hoenig of the Federal Deposit Insurance Corporation proposes? There is no sign of this in Mr. Powell’s view of the world, despite the fact that even William Dudley, the president of the Federal Reserve Bank of New York, views the first round of living wills (submitted last year) as inadequate.

In fact, global megabanks as currently constituted could in no way prepare a credible living will; they are simply too complex for their own management to understand – as demonstrated by JPMorgan Chase’s losses of more than $6 billion in the so-called London Whale case. The materials involved in a full disclosure would fill a small college library, and most of them would prove irrelevant once liquidation started. And any such document can immediately become out of date; a day of intense derivative trading can significantly change the risk profile of a big company, and the nature of the systemic risks that it poses.

Mr. Powell is an experienced financial sector executive and, behind closed doors, most such people are candid about the problems of megabanks. I’m sure that Mr. Powell’s intentions are good, but perhaps inadvertently he is siding with industry people who seek to use delaying tactics at every opportunity.

For example, Mr. Powell referred to the resolution of global megabanks without sufficiently emphasizing the inherent difficulties of cross-border resolution (see Pages 9-10 of his speech). Again, I am confident that Mr. Powell is fully informed about the lack of progress in creating an integrated resolution regime between Britain and the euro zone, as well as the serious difficulties within the euro zone itself.

Citigroup brags about having 200 million customer accounts in 160 countries and processing $3 trillion in transactions every day. How exactly does Mr. Powell or anyone else propose to unwind that when the cross-border issues are profoundly complicated and it’s every regulator for himself? Citigroup, after all, falls into a state of insolvency roughly every decade.

As for the cooperation between the F.D.I.C. and the Bank of England, to which Mr. Powell refers (again, see Pages 9-10), this is a valiant effort. But I have talked in detail with Paul Tucker, the relevant deputy governor at the Bank of England (including at the public meeting of the Systemic Resolution Advisory Committee of the F.D.I.C. in December). The Bank of England has a fundamentally different approach to bank resolution than that of the F.D.I.C. Both sides, by statute and under political pressure, must keep their options open.

In any crisis, national interest comes first, which means the potential for an unseemly scramble by regulators to grab assets. This is exactly how markets become destabilized.

Mr. Powell refers (see Page 6) to a “public simulation of the failure of large financial institution” under an ordinary liquidation agreement that he helped design in October 2011. And he draws encouragement from that experience, which refers to the simulation organized by The Economist at its Buttonwood conference. But according to top-level participants in that exercise, with whom I have spoken, the cross-border piece was designed to be trivial, with the relevant regulators presumed willing and able to cooperate, because the event had to fit within a two-hour time slot. The inherent complexity of modern cross-border banking was simply assumed away in the interest of making for good viewing.

This is not a serious way to think about financial crises.

If Mr. Powell were serious about ending too big to fail, he would express in public his support for efforts to measure the subsidies that these financial institutions continue to receive. The Fed is perfectly capable of calculating and publishing numbers that would be informative regarding whether these subsidies are rising or failing.

As I mentioned here last week, in the early 2000s the Fed staff calculated the federal subsidies to Fannie Mae and Freddie Mac at around 40 basis points (I cited a 2003 paper and a 2004 speech by Alan Greenspan, then the Fed chairman). Why not do analogous calculations for today’s too-big-to-fail financial institutions? I understand that Mr. Powell is not in a position to tell the Fed staff what to do, but calling for more precise measurement and public reporting on subsidies is hardly expressing a radical thought.

Any excuse that such subsidies are hard to measure (which is what I hear from the industry, not from Mr. Powell) is inherently lame. In fact, it would be laughable if that were ever to come from the Fed. Is inflation or the “natural rate” of unemployment easy to measure? The Fed is in the business of filtering out noise and understanding fundamentals.

Of course, the Fed did a very bad job across almost all dimensions of its mandate before the crisis of 2008. That is exactly why its legitimacy is called into question. It is baffling that so many Fed insiders refuse to understand how another financial crisis, centered on unfettered too-big-to-fail financial companies, would undermine the fragile political consensus that currently supports central-bank independence.

Broader political momentum is most definitely shifting toward confronting the power of very large financial institutions. On Tuesday, I was chairman of an event on “too big to fail” at the Peterson Institute for International Economics with Sheila Bair; Senator Sherrod Brown, Democrat of Ohio; and Jon Huntsman, the former governor of Utah and Republican presidential candidate. (You can watch the video on the institute’s Web site.)

Senator Brown made a strong case, from the left, for constraining the size of very large banks. Mr. Huntsman made a convergent case, from a conservative perspective, for measuring and ending the subsidies these financial institutions receive to maximize economic growth. Ms. Bair provided the hands-on, detailed view about how to move our current rules decisively and appropriately in the right direction.

Yet on Wednesday, Attorney General Eric Holder acknowledged that some of the largest financial institutions may have become too big to prosecute. “I am concerned that the size of some of these institutions becomes so large that it does become difficult for us to prosecute them when we are hit with indications that if you do prosecute, if you do bring a criminal charge, it will have a negative impact on the national economy, perhaps even the world economy,” he said in testimony to the Senate Judiciary Committee, reported on blog. “And I think that is a function of the fact that some of these institutions have become too large.”

Still, the Obama administration says it wants to promote women to positions of responsibility. Ms. Bair is not just the best woman for the job of supervision at the Fed; she is by far the best-qualified person. Is this White House serious about financial reform, or is it just paying lip service?

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Business Briefing | PEOPLE: Sheila Bair, Leaving the F.D.I.C., to Join Pew Trusts

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F.D.I.C. Chairwoman to Leave in July

This article has been revised to reflect the following correction:

Correction: May 9, 2011

An earlier headline on this article misstated the timing of Sheila Bair’s departure as F.D.I.C. chairwoman. She plans to leave in July, not next month.

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