I know most of you are simply glued to the screen waiting for some sign that Bernanke & Co. are about to flood another $10 trillion into global equity markets. And you may get your announcement yet (harbingers of death that you are).
However, there is a great deal of other interesting developments occurring at this meeting which you are perhaps overlooking, although they are right in front of your eyes.
One of the key purposes of this meeting seems to be to discuss the new framework of regulation required of the Fed by the Dodd-Frank bill. Now, in addition to the individual prospects of financial institutions, the Fed is also required to look at the big picture when making regulatory decisions.
In a speech given by Governor Daniel K. Tarullo, some extremely relevant phrases were uttered, in my opinion.
First, with regards to the place of the Fed and cheap money:
“The familiar, “microprudential” approach to regulation focuses on risk within individual firms. The ability to borrow at a risk-free rate conferred by deposit insurance, combined with the limited liability that is standard in corporate structures, presents banks with incentives to take on socially inefficient risks. This well-known moral hazard problem traditionally has been addressed through regulation and supervision directed specifically at protection of the deposit insurance fund. Thus, for example, traditional bank holding company regulation was actually fairly narrowly defined: It sought to protect insured depository institutions from the risks of their uninsured affiliates and to limit use of insured deposits to fund activities in other parts of the holding company. The potential effects of an individual bank’s behavior on the financial system as a whole–much less that of a bank holding company or unregulated financial firm–were generally not addressed in prudential regulatory laws and only unevenly considered in supervisory practice. “
The Fed is aware that letting major banks borrow from them at super cheap rates is creating market inefficiencies and mal-investment which could create more problems down the road. Thus, they may look to avoid letting the window be used again during market problems in the future, opting instead for preeminent “strong hand” policies.
The second, has to do with the economies of scale:
“Well before the financial crisis and my arrival at the Federal Reserve, I had found that the relative dearth of empirical work on the nature of economies of scale and scope in large financial firms hindered the development and execution of optimal regulatory and supervisory policies. Some regulatory features added by the Dodd-Frank Act only increase the importance of more such work to fill out our understanding of the social utility of the largest, most complex financial firms. Ultimately, we want to understand what these scale or scope economies imply for the degree to which large size or functional reach across many types of financial activities is essential for the efficient allocation of capital and liquidity and for the international competitiveness of domestic firms.
Significant economies of scale in terms of production costs have been demonstrated for services related to payment networks. Generally, though, even where intuition suggests economies in some other areas–such as the breadth of securities distribution networks and the ability to provide all forms of financing in significant amounts–evidence for the existence of such economies is limited and mixed. Moreover, even where significant scale is necessary to achieve certain economies, an important question will be what the minimum efficient scale–or, perhaps more realistically, the minimum feasible scale–actually is. It is possible that a firm would need to be quite large and diversified to achieve these economies, but still not as large and diversified as some of today’s firms have become.”
People in the Fed, and not just this governor either, are finally starting to question whether there is any advantage to having gigantic banks. We know that having larger institutions exist lets them work in volume, letting them lower costs for clients and consumers. However, at what point does that ability become a liability? There is very little complete work in the study, as economies of scale, before now, have been assumed to always be advantageous. Obviously, that isn’t always true. The Fed is beginning to question the soundness of this poor logic.
Which leads us to the coup de gras; the single most important statement uttered as of yet is this one:
“While much of the interchange I have in mind will simply add nuance to existing work, we must recognize that some earlier findings about optimal market structure or regulatory policy may not hold once researchers incorporate systemic risk considerations into normative standards about what constitutes an efficient outcome. As specific regulatory proposals or acquisitions are considered, we may well identify tensions between the traditional IO approach to antitrust and regulation, on the one hand, and the goal of maintaining the stability of the financial system, on the other.”
What I have taken this to mean is that the Fed is not complacent with the size of existing financial institutions. If this line of inquiry continues, it would mean, in my mind, that the Fed believes the likes of JPM, GS, C, and friends to be too big.
In the very near future, perhaps as early as next year, we may witness the first forced splitting of a major U.S. banking operation in our lifetimes.
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And why would this say be necessarily bad for BofA away from the puts and warrants problems?
They could split BofA east and West and let Merrill sail off into the sunset. I don’t see this as a bad thing. i also don’t see Fed meddling in size as a good thing either. Banks themselves should determine their own size if too big to fail is taken off the table.
I don’t know, I mean we got to the point of having anti-trust laws for a reason.
The number of mergers in recent years have been ridiculous, all in an attempt to create some vast financial empire for one lonely, sadly overwhelmed individual to be emperor of. For each Jamie Dimon who, for the moment, is capable of filling the role required, you have a Vikram Pandit, Stan O’Neal and Ken Lewis who are in way over their heads.
If we’re going to insist on backstopping the financial sector, we should have a say in how big we let these companies get. If you want to permanently shutter the Fed window and only let the banks play with their own money and talent, then sure, have at it. They can get as big as they want, bankruptcy not withstanding.
That’s all true.
However if you want that sort of system you are going to have to see bank capital hiked to 25% in the way old Republic National Bank of New York was capitalized.
the system we have now is a low capitalized banking system in the hope that they lend and spur growth.
Frankly I don’t understand all the hatred of the banks in the US. It’s like people have lost their heads.
Banks are in a high risk business of losing on loans. If they have a low capital base they will get into trouble in the same way large industrial firms do at times and have to write off a large part of their net worth.
There was a sudden and abrupt down move in asset values after two extraordinary decades.
Banks lost money and had to be rescued and if they weren’t Main street would be eating children for protein.
Banks financed a large part of the growth from 1990 to 2007 with a small capital base. It shouldn’t shock anyone that after coming off that boom they lost money.
I don’t disagree with you. But if we’re gonna roll that way, then we should at least avoid having entities with $10 trillion under management; get some diverse investments in there, and maybe some second opinions that could save a portion of the infrastructure at least.
As of right now, when one of these groups is wrong about anything, calamity ensues.
Cain
Banks move in herds. That’s what they do and have always done because loan demand chases them.
There were rules about banks being too big in the 20’s and you had laws then precluding banks from having branches elsewhere, admittedly, communication as different then.
they had huge numbers of failures then. Being smaller didn’t change a thing.
If banks in total are carrying $1 trillion of bad assets it can mean 50 small ones carry the loss or 3 do. It won’t change a thing as you’ll find they are all carrying the same shit on their books.
Diversification is crap. What is the Fed going to do.. is it going to tell buttfuck bank not to have as much lending in res real estate because copitinbankside bank is? Of course .
Canada does fine with fewer banks and they never got into trouble.
oops of course not.
True, that’s a good point.
Also Frankly I would have thought efficiency could also be examined by comparing the smaller and larger banks operating costs.
Eggzelent, Sir.
Nice insight…thanks.
It’s the federal backstop combined with the size that’s the issue. That was the whole point of glass-stegal. I could care less how bid $GS gets if we weren’t backstopping them AND there were some sort of market visibility for the custom products they cook up. This is where D-F will fail. You can never build regulations fast enough to keep up with the markets. The publicly backstopped insitutions should be segregated from the rest, and the rest should have public visibility of their risk so we don’t get into bailing out counterparty risk because it’s mispriced.
BAC just downgraded.
I covered shares of AWK I had purchased on August 2 for $27.67 apiece at a price of $30.54 today. I’m still retaining my core position.
Locking in some gains, upping my cash stake.
Portfolio: AEC, CLP, AWK, BG, CCJ, silver, 20% cash, and short UCO and TMF.
Amazing in this shyte AWK actually upped their earnings projections Monday night. I see they are also on JP Morgan’s list of possible S&P 500 contenders.