Cato Institute 30th Annual Monetary Conference, Part 2

Moderator: Zanny Minton Beddoes
Economics Editor, The Economist

Thomas Hoenig
Vice Chairman, Federal Deposit Insurance Corporation

Tells us to be skeptical of changes in financial regulation.  Incentives have not changed to favor increased leverage in financial institutions.  Protecting big banks has further worsened incentives.

Safety net started w/FDIC — insuring bank deposits makes payments system safe.  Investment banking, more volatile stays outside.  As commercial and investing banks were made to compete, the safety net expands, de facto.

1) Banks should spin out their investment arms into separate entities.

Lehman had a short-financed balance sheet, and relied on the government to protect them.

2) Need to rethink the capital approach.  Dump Basel.  Simplify, it is too easy to game.  Increase capital levels.  (DM: As I say, dumb regulation is good regulation.)  Need a simple tangible capital ratio.  Need to negotiate a tangible capital ratio, and a transition period.

Tangible capital during unregulated periods 13-16%.

3) Re-establish bank supervision as a tool to uncover risk.  Real supervision would find risks, and raise capital when needed.  (DM: how do we get mean regulators back.)

Jeffrey A. Miron
Senior Fellow, Cato Institute, and Director of Undergraduate Studies in Economics, Harvard University

Should we try to avoid market crises?

1) Avoiding crises is not a main goal of policy.

Policy in his view is maximizing economic growth.  Growth was not materially affected by crises 1790-1915.  (DM: his log graph hides the real panics.)

Great Depression and 2008-2012 are unique events.  Criticizes Bernanke view of the Great Depression, where bank failures happened near the bottom of the cycle.

Reinhart & Rogoff — recoveries after panics are slow.  Happens because debts have to be reconciled.  (Has a variety of less realistic reasons for the slowness.)

2) Policies to stop crises may hurt more than help.

Policy should be neutral to the sectors of the economy.  Bernanke’s policies are not neutral, aiding housing.

People want to reduce volatility, but that could hurt more than help.

He argues that we should promote freedom and growth.  Reduce government, etc.

Lawrence H. White
Professor of Economics, George Mason University

Create an anti-fragile banking system, a la Taleb.  Anti-fragile: gets stronger from small problems.

Suggests reducing deposit guarantees, and eliminating central banking, because they increase fragility.

Banking is not naturally fragile, White says. (Lots of hand waving, and looking at foreign examples where small failures did not impair the system.)

Suggests that pledging not to bail out banks will make everyone more careful.

We have a less-diversified financial ecology where many are pursuing a single strategy.  Heuristics of having a high tangible capital ratio would aid regulation.  Basel III is the wrong idea — too complicated, and Basel I & II did not help.

Robert L. Hetzel
Senior Economist, Federal Reserve Bank of Richmond

What do central banks control, and how do they control it?  Macro models turn correlation into causation, and obscures the the buildup in debt, which eventually collapses.

If you want to understand causation, you have to have models.  Uses an example from the 1812-1820 period, where small Treasury notes expand the monetary base, leading to inflation, a run for gold, and later a collapse.

Runs out of time.  Suggests we need more intelligence regarding what central banks can and can’t do.


Hoenig: Unlimited liability would be good, but you will politically never get there.

White: Banks arbitrage risk weights.  Zero risk weight for government debts were a fail.

Poole Q: Economics not hard, but the politics are hard.  Eliminating bailout support is impossible — in a crisis, bailouts happen, unless you eliminate the authority, or narrow the banking institutions.

Did existence of the FDIC cause the crisis? Risk-based insurance premiums?  Hoenig: we do risk-weight in some ways… but could you create a bank run from that?

Hoenig: FDIC has a reinsurer, the US Treasury.  White: clearinghouse model worked pre-Fed.

Hoenig: Sweden increasing capital standards above Basel.

I asked my question on asset-liability mismatch — the answer was the usual that you can’t end maturity transformation, and that taking duration risk is a risk like any other.