WASHINGTON — Neel Kashkari shocked much of the financial world Tuesday by saying the Dodd-Frank Act was insufficient and that breaking up the big banks and turning them into public utilities may be the only way to end "too big to fail."
In his first public speech as president of the Federal Reserve Bank of Minneapolis, he said Congress and regulators need to consider a more radical approach to preventing future bailouts. His message was unusual enough because it came from a sitting head of a Fed regional bank, but it was all the more powerful because Kashkari is a former Goldman Sachs executive and chief architect of the Treasury Department's 2008 bailout program.
"While significant progress has been made to strengthen our financial system, I believe the [Dodd-Frank] Act did not go far enough," Kashkari said. "I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy."
Kashkari credited Dodd-Frank with increasing capital requirements on banks and said that has reduced systemic risk. But he said some other key reforms, including resolution plans known as "living wills," are proceeding at a glacial pace and it is unclear if regulators would even use their new tools if they faced a future crisis.
"Given the massive externalities on Main Street of large bank failures in terms of lost jobs, lost income and lost wealth, no rational policymaker would risk restructuring large firms and forcing losses on creditors and counterparties using the new tools in a risky environment, let alone in a crisis environment like we experienced in 2008," Kashkari said. "They will be forced to bail out failing institutions—as we were."
Kashkari went on to suggest that regulators and Congress should consider breaking up the banks into "smaller, less connected, less important entities"; requiring banks to become public utilities by holding "so much capital that they virtually can't fail"; and "taxing leverage throughout the financial system."
In a panel presentation right after his remarks, he clarified that he was not necessarily advocating for banks' breakups, but said that "it's one of the solutions" that should be considered.
He also said that the Minneapolis Fed will be launching a far-ranging initiative "to consider transformational options and develop an actionable plan to end TBTF," including symposia, research efforts and cost-benefit examinations of different policy options.
Kashkari, who ran an unsuccessful campaign for governor of California as a Republican in 2014, has staked out a political position with his comments that are more in line with the views of Wall Street hawks like Democratic Presidential candidate Bernie Sanders, I-Vt., and Sen. Elizabeth Warren, D-Mass., who have repeatedly criticized regulators for not being fast or stringent enough in their oversight of the largest banks.
But Kashkari's comments met skepticism from fellow panelists and former Fed members on the Brookings program. Don Kohn, former vice chairman of the Fed during the financial crisis, he was not convinced that post-crisis reforms had failed to adequately address "too big to fail." Kohn said such a judgment was likely impossible to make with certainty, especially given the incomplete status of the living wills process.
"I certainly share Neel's objective of ending 'too big to fail' — that is, allowing any large financial institution to fail with minimal damage on the financial system and the economy," Kohn said. "I don't know why [Dodd-Frank reforms] won't work."
Former Minneapolis Fed President Gary Stern, meanwhile, similarly expressed skepticism of Kashkari's dour view of Dodd-Frank reforms, saying that calls for vastly expanded capital rules might be effective in some ways, but that other options available to regulators have hardly been considered. For example, requiring banks to have an independent chairman of the board, independent board members, or other measures to affect the makeup of banks' internal management structures could be more effective than inflexible external regulatory rules, Stern said.
"I don't think [Kashkari's plan] takes advantage of other improvements we could make," Stern said. "In my experience, senior bankers are willing to push back or ignore regulatory pressure. They are less likely to do so when they're getting pressure from their boards of directors, and that's an avenue that has been underutilized to date."
Kashkari said his decision to stake out such a hawkish position so early in his tenure was one of conscience. Since joining the Minneapolis Fed late last year and becoming president on Jan. 1, he has become increasingly convinced that systemic risk remains in place and that he should use his position as head of the regional Fed bank to advocate for more stringent reform.
"If I'm not willing to stand up and share my concerns, then I wouldn't be doing by job," Kashkari said.