Posted by Karl Denninger
A speech by Kansas City Fed President Thomas Hoenig has raised some interesting points…. interesting in that they tend to mesh well with what I have preached for three years.
When did Thomas get a brain transplant? Not that it matters when it comes to outcome, but one does wonder – has Mr. Hoenig had a “come to Jesus” moment looking through some of The Fed’s “privileged” information, and does he see what’s now around the bend?
When the markets are no longer competitive, firms become a monopoly or an oligopoly and it matters more who you know than what you know.
That wouldn’t include our former and present Treasury Secretary, would it?
We have seen the formation of a powerful group of financial firms. We have inadvertently granted them implied guarantees and favors, and we have suffered the consequences. We must correct these violations.
I would argue that there was nothing inadvertent about it, but other than that, Mr. Hoenig is spot-on. Indeed, I’d argue that these “favors” and “guarantees” were granted literally at gunpoint, although the “gun” used has alternated between bribery and extortion.
If the top 20 firms held the same equity capital levels as other smaller banking institutions they would require $210 billion in new equity or reduced assets of over $3 trillion, or some combination of both.
Mr. Hoenig does not, however, speak to the even-larger problem – that is, the fact that the supposed “equity capital levels” are fictions that were allowed to come into play as a direct and proximate consequence of the above “extortion and bribery” regime.
This is specifically true in the case of HELOC loans that are behind underwater defaulting first mortgages. Again, as I have pointed out repeatedly, recovery value on such a loan is essentially indistinguishable from zero.
Second, we must strengthen our supervision of financial firms by returning to simple, well-established rules, such as maximum leverage and loan-to-value ratios.
Gee, you mean 28/36 (Front/Back end) for mortgage lending and the maximum leverage (14:1) ratio for large financial firms was a bad idea? Who worked “tirelessly” for the second? Oh yeah, that was our former Treasury Secretary Henry Paulson, who then argued “too big to fail” and “tanks in the streets unless you fork over $700 billion” when it all blew up in his face.
Mr. Hoenig also endorsed the ending of OTC credit-default swaps for all standardized contracts (and by the way, you can de-construct nearly all custom contracts into two or more standardized ones!) along with ending the “pass-through” nature of funding for things like hedge funds, along with a ban on proprietary trading.
All in all it’s nice to see Thomas Hoenig wake up. Now let’s see if we can get CONgress to stop opening the bribe envelopes, er, ignore the campaign contributions for a sufficient period of time to actually fix this mess, forcing those “big banks” to get that leverage ratio down to where it belongs, along with marking their assets to the market.
(Yes, I’m well-aware that this means we will have fewer big banks as some will need to be “resolved.” So be it. The essence of Mr. Hoenig’s argument is that the smaller, community and regional banks are in fact preferable anyway – simply because competition between more players is to the benefit of the consumer and economy generally over a handful of big, oligopolistic firms.)