WASHINGTON — Minneapolis Fed President Neel Kashkari fired back Monday at those who argue "too big to fail" has been adequately addressed by post-crisis reforms, contending that the new structure is too complicated to work in a real-life scenario.
In a speech to the Peterson Institute for International Economics, Kashkari said the living will process does not "inspire a lot of confidence," while criticizing regulators' total loss absorbing capacity rule, which theoretically imposes losses on long-term debtholders of a failing big bank. Kashkari said that after two other symposiums on the issue, the consensus is that there needs to be a significant restructuring of the financial system.
"The only disagreement was about the scale and the speed of that restructuring," he said in his prepared remarks.
Kashkari's harshest critique was reserved for TLAC, a rule the Federal Reserve Board finalized last year to force banks to issue unsecured debt that could be converted into equity in a successor bank — essentially acting like a built-in bailout to avoid the need for taxpayer funds. Building on criticisms he issued in April, Kashkari said the rule is too complicated.
"This approach is too complex and has too many moving parts to work when we need it to," he said. "Complexity is the enemy of a robust plan."
He argued that expecting long-term debtholders to absorb losses for a bank's failure was unrealistic.
"A policy analyst recently asked me if we really could resolve a large bank during a crisis," he said. "I responded by asking him if he thought we could dismantle an aircraft carrier in the middle of a hurricane."
Moreover, the plan puts too much faith in regulators, Kashkari said.
The Minneapolis Fed president addressed the possibility of imposing lower equity requirements and encouraging quick regulatory action if a bank were to head into trouble. "This approach assumes that all-knowing, well-intentioned regulators, seizing a bank earlier, will somehow reduce the total losses the bank ultimately faces," he said.
Kashkari also argued that regulators have tried to have their cake and eat it too, when saying that the cost of high capital requirements could be paid for by lower risks faced by banks.
"It strikes me that a regulatory framework that relies on investors' mispricing risk may work for a time, but isn't likely to work over the long term," he said.
Kashkari also pointed to the living wills' results — in which regulators found that only one out of eight systemically important U.S. banks' plan passed both regulators.
"The living will of the one final bank, the best of the group, wasn't actually rated 'credible,' " Kashkari said. "It was just not 'not credible.' That doesn't inspire a lot of confidence."
In a Q&A session after the event, Kashkari was skeptical of the possibility of resolving a large bank through bankruptcy. If a court were to make a critical decision during a crisis, he said, "Does that spread risk and increase uncertainty rather than contain risk?"
Even if the living wills process successfully prompts big banks to make significant structural changes, there is still a long way to go, he said.
"A lot of improvements are taking place. But 'A' for effort is not good enough," Kashkari said. "We actually need credibility."
Even stress tests were an insufficient measure of a bank's health, he said. "Stress testing generally is a good exercise," he said. "It's just incredibly difficult to foresee the future."
Kashkari was asked whether he supports the reinstatement of the Glass-Steagall Act. While he replied that he didn't have a "religious opposition" to restoring the 1930s-era law that separated commercial and investment banking , he wasn't sure it would help much either.
"I don't think, by itself, it's a complete solution to the 'too big to fail' problem," he said. "I'm not sure that it changes very much."
Kashkari did, however, back a bill by House Financial Services Committee Chairman Jeb Hensarling to give regulatory relief to banks that hold higher capital.
"The notion of let's solve 'too big to fail' and then relax regulations on those that are not systemically important, I support that," Kashkari said. "The regulations have swung too far in terms of the behavior that it's forcing banks to adopt in evaluating behaviors."
He said he had sympathies for small banks in the current environment.
"When you add a compliance officer to a small bank, it really changes their profitability," contrary to adding a compliance officer on a large bank's payroll, he added. " 'Too big to fail' in some sense has gotten work as a result of these regulations."
But when asked if regulatory proposals beyond Dodd-Frank are politically viable, Kashkari said his message had struck a chord among the public, but also among policy analysts and other experts.
"It seems like a lot of people on both sides of the aisle recognize that more probably needs to be done," he said. "At the end of the day, it's going to require the American people to make the call."