By Yali N’Diaye

WASHINGTON (MNI) – As Congress works on the financial regulatory
reform bill, it should address the issue of too-big-to-fail by capping
the size of systemically important institutions or break them up, Dallas
Federal Reserve Bank President Richard Fisher said Thursday night.

That approach is the only effective one to end the too big to fail
problem, as an enhanced regulation or regulation regime, or even a
combination of both would not be enough to address the issue, the Hoenig
said in remarks prepared for the SW Graduate School of Banking’s 53rd
Annual Keynote Address and Banquet.

The speech, focused on the too-big-to-fail issue and how to best
address it as the financial regulatory reform is still being carved out,
made no reference to monetary policy or the economy.

Fisher also told the audience of students that European regulators
seem to take the path of enhanced regulation and resolution, which is
unfortunate, since Fisher does not think this is efficient.

“Unfortunately, in attempting to address TBTF, the European Union
is falling into the regulate ‘em and resolve ‘em camps, leaning toward
capital regulation and enhanced resolution regimes as a way to limit
systemic risk,” he said Fisher, who won’t vote on monetary policy
decisions until 2011.

This is especially unfortunate as “adverse effect of rising
sovereign credit risk on euro-area banks has led to renewed concerns
about systemic risk.”

The right way to address TBTF, Fisher said, is to “cap their size
or break them up — in one way or another shrink them relative to the
size of the industry.”

Acknowledging arguments against shrinking the size of large banks,
Fisher said, “sufficient or not, ending the existence of TBTF
institutions is certainly a necessary part of any regulatory reform
effort that could succeed in creating a stable financial system. It is
the most sound response of all.”

That is not to say that large institutions don’t have their place
in the financial system. And they do, in fact, have their “virtues.”

But to be clear, what the financial system does not need “are a few
gargantuan institutions capable of bringing down the very system they
claim to serve,’ Fisher said.

The two other approaches — regulation and a resolution regime —
would not be efficient to prevent problems related to the size of the
large firms, even combined, Fisher said.

“I find it highly unlikely that such institutions can be
effectively regulated, even after reform,” Fisher argued.

he added, “There is little evidence that new regulations, involving
capital and liquidity rules, could ever contain the circumvention
instinct.”

He said capital regulation has not proved to be efficient
historically.

Besides, “Requiring additional capital against risk sounds like a
good idea but is difficult to implement.”

Neither would a resolution regime for large institutions, even if
it is credible, produce the intended effect.

“Unfortunately, imposing creditor losses at a failing big bank,
while simultaneously avoiding market disruptions, involves more than a
bit of sophistry,” the central banker said.

Enforcing such a process would also be difficult, he said,
“especially when regulators are explicitly directed to mitigate
disruptions to the financial system, as they are in the proposed reform
bill.’

Not to mention technical obstacles to a resolution regime, “such as
the difficulty of quickly estimating a rate of recovery on a large and
complex banking organization and paying it out to creditors.”

Should congress draft an effective resolution regime, Fisher
stressed regulators are unlikely to use it.

“There are myriad ways for regulators to forbear,’ he said, citing
“accounting forbearance” or special liquidity facilities that provide
funding relief.

“Systemwide programs are unfortunately a perfect back door through
which to channel big bank bailouts,” Fisher said.

And such bailout are often the only credible choice for policy
makers.

“Again, in my view, enhanced resolution regimes, by themselves, are
not enough to end TBTF,” he concluded. “Even a combination of enhanced
regulation and resolution would likely be inadequate.”

** Market News International Washington Bureau: 202-371-2121 **

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