Regulators don't need more power to prevent Great Recessions

See Alan Blinder’s Risk-Assessment Approach Is Mistaken. WSJ letter to the editor. 

"Alan S. Blinder and I have the same goal: a more stable financial industry (“Empower Regulators to Stop Risky Financial Business,” op-ed, June 20). Unfortunately, his solution will solve little.

Mr. Blinder proposes equipping regulators—specifically the Financial Stability Oversight Committee (FSOC)—with more power to control risks to the financial system. Experience makes me skeptical. Before the last financial crisis, bank regulators and the Securities and Exchange Commission had plenty of power to stop the increase in leverage occurring among the largest banks, which seriously destabilized the industry. They chose not to. Some now admit they had only a vague notion of the risks, and thus lacked decisiveness.

Mr. Blinder suggests that, as a political appointee, the secretary of the Treasury is reluctant to act. That doesn’t explain the Fed or SEC’s reluctance with banks that were later bailed out. He is also concerned with the FSOC’s confinement to an oversight role. But each FSOC agency has a long track record of authority not exercised in the face of political winds.

A better alternative is requiring systemically important bank companies to hold more equity capital. Ten to 15 cents per dollar of total assets, rather than the three cents they held before the last crisis or the modest six cents they hold today, would be effective. Institutions that hold more investor capital are more stable, less prone to contagion, better able to support borrowers during recessions and, should they fail, less costly to resolve.

The industry claims requiring more capital would push financial activities outside the regulated sphere, such as into hedge funds. Perhaps, but the market appears to know this and requires significantly more capital of them than of regulated banks.

Supervisors have proven no better than bankers at judging risk. Bank capital above current levels won’t end failure or recessions, but it will help keep them from becoming Great Recessions.

Thomas Hoenig
Kansas City, Mo.
Mr. Hoenig is a former president of the Federal Reserve Bank of Kansas City and former vice chairman of the FDIC."