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Kashkari's too-big-to-fail push faces institutional resistance


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According to Market Intelligence, April 2023

Kashkari's too-big-to-fail push faces institutional resistance

Itappears Neel Kashkari, the new president of the Federal Reserve Bank ofMinneapolis, has a long road in convincing his colleagues that more needs to bedone about too big to fail.

On April4, Kashkari hosted a symposium on ending too big to fail, headlined bywell-known banking critics Anat Admati, a professor at Stanford University, andSimon Johnson, a professor at the Massachusetts Institute of Technology.

Whilemuch of the morning session echoed Kashkari's call for additional measures tofix too-big-to-fail, pushback from the audience during a contentiousquestion-and-answer session suggested others across the Federal Reserve Systemdo not agree.

Admatiled the morning session, focused on increasing equity requirements. Admati wentthrough the financial crisis, arguing that regulatory capital ratiosaccomplished little since they rely on risk-weighted assets.

Severalother panelists agreed with Admati and took shots at inadequacies in the newregulatory framework. But, for at least some of the audience, it did not appearas if those shots landed.

V.V.Chari, a consultant for the Federal Reserve Bank of Minneapolis, kicked off thequestion-and-answer session with a fiery rebuke of many of the panelists'comments.

"Passionand anecdotes are an attempt to substitute for serious analysis," Charisaid.

Hesaid Admati's call for banks to carry equity equal to 15% of total assets anincorrect, arbitrary approach because it treated all banks the same and thatany one-size-fits-all solution cannot be the correct solution. He saidempirical analysis was required to accurately estimate the size of damage afinancial crisis causes the economy in order to find the appropriate solution.

Implicitin all calls for additional reform is the assumption that the 2008 financialcrisis made the recession worse, something that has not shown up in theempirical research, Chari said.

JamesBullard, president and CEO of the Federal Reserve Bank of St. Louis, followedup with a similar line of questioning, asking Admati if she used theDiamond-Dybvig model of what happens in a financial crisis.

Admatisaid the Diamond-Dybvig model was insufficient because it focuses on theliquidity of a bank, not its solvency. Admati acknowledged that 15% equity wasan arbitrary figure but said estimating a correct figure is impossible in thecurrent environment.

Essentially,Admati said, the financial sector is so distorted that it is difficult to relyupon models. If the system were not so distorted, Admati said, banks would notresist the calls for additional equity since the cost would be close to thecost of debt.

"Thefact that [equity] matters itself proves to you that we're not there,"Admati said.

Anotherpanelist, Adam Posen, president of the Peterson Institute for InternationalEconomics, bristled at the notion that empirical models were the be-all,end-all. He said he expected some amount of shame about empirical economicanalysis among Minneapolis Fed economists considering the "uselessnessthat came out of the institution in the past," an apparent jab at the bank'srole in the development of rational expectations theory. He said economicmodels have a long way to go before being reliable.

"Ifeconomists want to be like physicists, we're in the stage of Kepler, not in thestage of Einstein," he said.

Anotherpanelist welcomed the audience pushback. Phillip Swagel, a professor at theUniversity of Maryland, said regulatory reform needs to rely on seriousresearch and analysis.

"Abunch of quotation marks from a motion picture doesn't meet my standard,"Swagel said in reference to Admati's presentation, which included quotes fromthe move, "The Big Short."

Atone point, Posen said these critics were not operating in good faith, ignoringempirical analysis that did not fit their narrative and creating straw-manarguments. A conference attendee raised skepticism that additional capitalrequirements would prevent fraudulent behavior by banks.

"Ifyou had bothered to listen to my remarks," Posen said in response, "Iexplicitly said that."