Neel Kashkari, the new president of the Minneapolis Federal Reserve, is a breath of fresh economic air with his proposal voiced last week to break up big banks. In doing so, he furthers an intellectual tradition at the Minneapolis Fed. In large families, the smallest kid often has to act out to get any attention, and that seems to have been the guiding principle over four decades for this smallest of America’s 12 Fed District banks.
This approach started in the late 1970s, when the bank allied itself with “rational expectations,” a new economic school of thought then well outside the mainstream. It continued under Narayana Kocherlakota, president from 2009 through 2015. After a “road to Damascus” conversion from his earlier orientation, Kocherlakota became the most prominent advocate within the Fed system of even greater monetary expansion and lower interest rates — including a possible negative-rate approach. He continues to press that case from academia.
Now Kashkari, his successor, a former Treasury Department bank-bailout tsar, is drawing national attention to Minneapolis with a new level of outspokenness. In the position only six weeks, his first major speech in Washington threw down a policy gauntlet with his call to break up big banks.
I find this very good news for a number of reasons. Foremost, our nation’s economy, and hence that of the world, is still vulnerable to the havoc that might be brought on by a full-blown financial crisis like the one we narrowly escaped in October 2008. The “too-big-to-fail” problem Kashkari’s proposal addresses remains alive and well. And it clearly is going to be an issue in the 2016 presidential campaign.
Democratic candidate Bernie Sanders is right that the very biggest financial firms have too much economic and political power. Republican candidates who criticize the post-crisis Dodd-Frank legislation that regulated the banks have some points.
Dodd-Frank is complicated. Compliance is cumbersome, and the law imposes real and substantial costs on the financial sector and hence on our general economy. It does motivate economic inefficiencies. I know of no economist who sees it as ideal.
However, just as with the Affordable Care Act, its critics need to be able to suggest some viable alternative. Vague promises to “repeal and replace” are nonsense if never coupled with concrete proposals. That is where Kashkari comes riding in.
Simply denying that extremely large financial institutions pose an ongoing structural threat to the U.S. economy is folly. Saying that all will be hunky-dory as long as we simply let all teetering firms go into bankruptcy is dangerous folly. Right now, there are some firms that, if left to go bust, would cause deep financial crisis.
Yes, in the past, the TBTF doctrine was invoked too readily to save banks like Continental Illinois in 1984 or funds like Long-Term Capital Management in 1998. Cry wolf and bail out every single failing bank, and you create incentives for all large firms to take on excessive risk. Gary Stern, another former Minneapolis Fed president, warned about this 15 years before events proved him right. Stern was particularly articulate and prophetic on the issue.
But pointing out the moral hazard created by past TBTF bailouts only bolsters Kashkari’s argument. If firms like Goldman Sachs (where Kashkari used to work), JPMorgan and Citigroup pose a danger by their very size and because they are difficult to regulate, then one solution is to not have any firms this big. Many highly respected economists have been saying this for years.
John Boyd, also a long-time Minneapolis Fed researcher before moving to an endowed chair at the Carlson School at the University of Minnesota, together with Ravi Jagannathan from the Kellogg School of Management at Northwestern University, have laid out the argument clearly for nearly a decade.
However, now that Kashkari has the bully pulpit of a Fed District Bank presidency, the issue is going to get broader attention. He is an unusually driven individual who is not hampered by any reputation as an abstract academic. He has worked on Wall Street and he is a Republican, albeit a moderate one by contemporary standards. At Treasury, under both George W. Bush and Barack Obama, he oversaw TARP, the controversial Troubled Asset Relief Program, that worked to save the very banks he now wants to break up or heavily regulate.
He has proposed three very specific options toward accomplishing the objective of limiting the power of big banks: (1) force large banks to break into smaller pieces; (2) have the government limit risk-taking by forcing the banks raise more capital versus debt; or (3) tax borrowing throughout the financial system.
Pushback on this from Wall Street will be enormous. The argument the mega-firms make is that they achieve economies of scale: We get more financial services for the same use of resources. Much research shows this isn’t really true. And if size means we have episodic economic cataclysms, minor efficiencies during the lulls means little.
The Minneapolis Fed is going to organize a number of events to further air Kashkari’s proposals. Pay attention to them, and hope that politicians from both parties do, too. Maybe this is one issue that the candidates could agree on by Election Day.