Treasury's Lew Aligns with Fed, Big Banks in TBTF Debate
Top Federal Reserve Board officials appear to have reached a consensus on how to deal with the "too big to fail" dilemma: wait for the current reform process to play out, but be ready to significantly increase capital standards if the problem remains unsolved.
Federal Reserve Board Gov. Jeremy Stein said Wednesday regulators should continue to implement current regulatory reform efforts designed to eliminate "too big to fail," but take further steps to strengthen capital requirements if needed.
Federal Reserve Board Chairman Ben Bernanke on Wednesday said regulators would take additional steps to eliminate the problem of "too big to fail" if current efforts fall short.
WASHINGTON Treasury Secretary Jacob Lew said Tuesday that lawmakers should hold off on further legislative reforms to the financial system until Dodd-Frank is fully implemented, echoing recent remarks from top Federal Reserve Board officials and executives of large banks.
During a Senate Banking Committee hearing, Lew was repeatedly pressed by lawmakers, including Sens. Sherrod Brown, D-Ohio, and Elizabeth Warren, D-Mass., who were skeptical that recent reforms are sufficient to eliminate "too big to fail."
Lew forcefully defended his position, arguing that Dodd-Frank and pending Basel III capital and liquidity rules must take effect first before further changes are contemplated.
"We need to see where the process ends in order to be able to answer the question whether we have fully solved the problem," said Lew, in his first appearance before the committee. "It is certainly the objective to be able to say in the end that we have ended 'too big to fail' and that we have eliminated any subsidy that might exist."
His remarks were similar to recent statements made by Fed Chairman Ben Bernanke and other top central bank officials who have been pushing back against the need for further legislation. Fed officials have said they have the authority and political will to raise capital standards on megabanks if those institutions continue to receive a funding advantage due to their perceived status.
"We will see if we are comfortable at that point, when that is all done, if we believe that the 'too big to fail' problem has been solved," said Bernanke, speaking earlier this month at the annual banking conference hosted by the Federal Reserve Bank of Chicago. "If not, certainly, one direction that we could go forward would be in my view, one constructive direction and a number of my board colleagues have talked about this is through the capital direction."
Bernanke said Dodd-Frank and Basel III must be given time to work before conclusions are drawn that the reform effort fell short. He has also expressed willingness by regulators to revisit the issue once the reform process has been finalized.
It was a sentiment repeatedly echoed by Lew at the hearing, which was supposed to be focused on a recent report by the Financial Stability Oversight Council, which Lew chairs, but instead was often dominated by separate concerns over recent actions by the Internal Revenue Service to target conservative groups.
"Our job right now is to implement a very important law with very powerful tools, and then take stock of whether or not there are other actions that are required," Lew said. "This is not the time to be enacting big changes to Dodd-Frank or to the regulatory system. We need to implement the law."
Lew's statement also dovetails with the view of several large-bank executives who have said that the current reforms must be given time to work before Congress passes new legislation.
Speaking at an investor conference Tuesday in London, John Stumpf, the chairman and chief executive of Wells Fargo, said "we do not need additional legislation aimed at big banks."
"Important and significant regulatory changes has been made since the financial crisis and we need to give existing regulations a chance to work especially now when all of our energies should be focused on creating growth and jobs," he said.
A key question in the debate over "too big to fail" is whether policymakers should place a size cap on the largest institutions to prevent any additional risk to the financial system. Bernanke recently said such an approach would be arbitrary and a better measure would be for the largest banks to hold more and better quality capital.
But Warren raised the same issue at the hearing as she tried to find out if the Treasury Department had reversed its position on limiting the size of the largest institutions. During the debate over the Dodd-Frank bill in 2010, Treasury Secretary Timothy Geithner strongly opposed an amendment from Sens. Brown and Ted Kaufman that would have put size caps on banks. The measure was not part of the final bill.
"How big do the biggest banks have to get," Warren asked, "before we consider breaking them up? They're 30% bigger now than they were five years ago. Do they have to double in size, triple in size, quadruple in size before we talk about breaking up the biggest financial institutions?"
Lew again sided with Fed officials, saying size alone was only one determinant of whether an institution would put the financial system at grave risk.
"What I'm worried about," he said, "is have we taken into account the measures that prevent systemic risk from being the kind of threat it was in 2008? Size is one factor, but size is not the only factor. I think we have to take into account all the factors that together add up to systemic risk."
Lew also expressed worry about a bill introduced by Sens. Brown, D-Ohio, and David Vitter, R-La., that would effectively scrap Basel III, saying policymakers need to take a more balanced approach. Their bill would require banks with more than $500 billion of assets to hold a 15% capital ratio, as well as scrap proposed Basel III standards and require bank subsidiaries to capitalize separately.
"The Basel III rules have not yet been finalized," said Lew, reminding lawmakers the global framework, which the U.S. has yet to adopt, is a "floor, it's not a ceiling."
Regulators agreed to indefinitely postpone the final rule implementing the capital and liquidity accord until they had time to review thousands of comment letters by community banks, but have suggested the rules would be due out soon. Lew said that backing away from the agreement would be a mistake.
"For a lot of the world, it becomes an aspirational goal, and we're trying to encourage the world to race to the top not race to the bottom," Lew said. "Basel III is actually working to pull a lot of countries up. Right now, when we look at the sources of financial risks, one of the things that we worry about given the global interconnection of our financial institutions is the risk that's presented to the United States from undercapitalized institutions around the world."
Asked whether regulators should consider creating a separate capital system for smaller institutions, Lew said the agencies are working to address community bankers' concerns with Basel III.
"They're, as they finalize their regulations, looking for ways to make appropriate distinctions to have the burdens be commensurate with the risk and not have small institutions that are not a source of risk be treated the same as large institutions that have a great deal of risk," Lew said.
With so many Dodd-Frank provisions still to be completed, Lew also stressed to lawmakers that his commitment as chairman of the FSOC would be to effect adoption of those measures as quickly as possible.
"I have actually stepped on the accelerator," Lew said. "I have gone to all the regulators and said this is more than just a question of implementing Dodd-Frank. This is a question of public trust in the government's ability to implement important policy that it said it's going to implement."
Alan Kline contributed to this article.