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Fed's Hoenig on the Failure to End Bailouts, and Why Another Crisis is Coming

KANSAS CITY, Mo. — Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, one of the most outspoken members of the Federal Open Market Committee, has never been shy when it comes to his opinion.

As his 20-year tenure comes to a close on Oct. 1, Hoenig sat down with American Banker to talk about a range of topics, including the missed opportunity to eliminate 'too big to fail' in Dodd-Frank, his duty to be forthright as the longest serving policy maker, and what his future plans might be — including the prospect of moving to Washington. This is an abridged edited version of the interview with Hoenig.

Q: You've been a strong critic of Dodd-Frank, how do you think the law has fallen short and how do we correct it?

HOENIG: The Dodd-Frank bill now defines what a systemically important financial institution is, which makes it now a kind of broad notice that these are the institutions that are 'too big to fail.' That means we will further concentrate our financial system to these powerful few companies, and therefore make it even more fragile in the sense of financial vulnerability to the taxpayer. I don't think that's healthy.

Q: Banks seem very concerned about how much capital they are going to have to raise as a result of Dodd-Frank and Basel III.

HOENIG: They're concerned about their return on equity, and I'm concerned about the safety of the banking system and the American depositor and taxpayer. All the safety net has done is allowed them to leverage up to their advantage on the backs of the American taxpayer. I have a hard time as a person, who is more concerned about the safety of the system and the taxpayer, to worry about their position.

Q: You've said the only solution is to break up the banks and strengthen the 'Volcker Rule.' Would that undo the codification of 'too big to fail'?

HOENIG: You can mitigate. You can make it less likely that they are 'too big to fail' because you separate out these horribly, complex instruments from the institution, therefore you can address the risk in those institutions more directly.

Q: Did Dodd-Frank make the financial system any safer?

HOENIG: I don't see it as more safe. I see it as less safe. My question is, How is it more safe? What's now making it more safe? Supervision? We had supervision. Capital? We had capital. Resolution? We had resolution. What's different about this? Complexity, less complexity? No. Better capital standards? Marginally, temporarily. What's better about it? You have to be able to tell someone what's better about it.

Q: You have said before it's inevitable we will have another crisis. What do you see as the next pockets of systemic risk?

HOENIG: You've got people who are in high regulatory positions today. You have legislators that are in key positions today talking about competitive disadvantage with other parts of the world. Therefore, we have to ease up on our rules, because we may be at a disadvantage. These institutions might go overseas. I only wish we worried about manufacturing the way we do with these financial institutions. We are already backing off our standards.

Q: Given what we know and what you've been through during the last financial crisis, will regulators be able to catch the next crisis, whether its five, 10, 15 years down the road?

HOENIG: It would be the first time in history. I would be very, very impressed.

Q: What's the problem?

HOENIG: Look it, I've got a crystal ball on my desk. It doesn't work. I can't predict the future. I can say I see the risk. I see the conditions in place. Zero interest rates, a very extensive easing of monetary policy, I can see that and those create conditions for credit bubbles. Now, it doesn't mean you are going to have a credit bubble, but they create the conditions. But everyone says, 'I don't see it, so therefore don't interfere with it.' Then the crash comes. No one wants to believe there is a systemic problem, so therefore there is no systemic problem until there is, and that's human nature. You can put all the systemic risk commissions in the world in place, they're human beings.

Q: Given that, what should regulators be focused on?

HOENIG: What regulators should do is regulate, supervise. I'm sorry; I'm not a strong stress test guy. I'm an examiner guy. I want to go in and look at the books. I want to test their systems. I will tell you on Basel III, Basel II you cannot rely on the institution to tell you the truth. Because when things get tough, when the market starts to fall, they can't because it puts them out of business. That's why you have examiners. You have to go in and say, 'I want to crack the books. I want to follow this loan. I want to verify the collateral, the quality of the collateral. I want to test it.'