Economic Insights:
Conversations with the Dallas Fed
Webcast Series
“Ending Too Big To Fail:
A Program for Financial Reform” &
Regional Economic Update February 1, 2013
hosted by FIRM - Financial Institution Relationship Management
Regional Economic Update
Anil Kumar Senior Research Economist and Advisor
hosted by FIRM - Financial Institution Relationship Management
The views expressed are those of the speaker and should not necessarily be attributed
to the Federal Reserve Bank of Dallas or the Federal Reserve System.
Overview
Robust job growth in 2012 but slower in second half
Stronger than the nation
– 2.9% job growth in Texas vs. 1.4% in the U.S. in 2012
Sources of Strength
– Construction and real estate
– Energy sector has slowed but still robust
Pockets of weakness
– Manufacturing
– Exports
Job growth likely to moderate somewhat in 2013
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Job growth remains robust but slower
in second half
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-8
-6
-4
-2
0
2
4
6
2005 2006 2007 2008 2009 2010 2011 2012
Texas U.S.
Q/Q Job Growth,
SAAR
(quarterly employment is last month of a quarter)
Texas Average
Since 1990
U.S. Average
Since 1990
2012: U.S. 1.4%
TX 2.9%
TX 2.2%
2011: U.S. 1.4%
Contributions to job growth: 2012 vs. 2011
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22.3
16.5 16.2 14.4
7.4 7.1 5.7 5.4 3.6
1.9 0.2
26.4 28.4
14.2 16.0 16.5
4.5
13.4
6.3
2.0
-28.2
0.4
-30
-20
-10
0
10
20
30
Prof. &
Bus. Svcs.
(13.1%)
Trade,
Transp.,
Util. (20%)
Leisure &
Hospitality
(10.1%)
Educ. &
Health
(13.5%)
Oil & Gas
Support &
Extraction
(2.4%)
Const.
(5.4%)
Mfg.
(7.8%)
Financial
(6%)
Other Svcs.
(3.5%)
Govt.
(16.4%)
Information
(1.8%)
2012 2011
Share of Total
Job Growth
Unemployment rate drops sharply
since August
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7.8
6.1 5.8
3
4
5
6
7
8
9
10
11
2000 2002 2004 2006 2008 2010 2012
Percent, SA
Texas
U.S.
Texas
ex-Border
Residential construction activity
continues to trend up
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20
40
60
80
100
120
140
160
180
2006 2007 2008 2009 2010 2011 2012
Real Residential Contract ValuesHousing StartsSingle Family PermitsMulti-Family Permits
Index Jan. '06=100,
5MMA
Housing market recovery remains strong
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3
4
5
6
7
8
9
10,000
12,000
14,000
16,000
18,000
20,000
22,000
24,000
26,000
2000 2002 2004 2006 2008 2010 2012
Total Sales, SA
6MMA Months in
Inventory, SA
Texas Existing Home Sales Texas Inventory of Unsold Homes
2012 Percent Growth in House Prices (YTD)
Median Sales Price (Dec) 5.54
S&P/Case Shiller Index (Nov) 5.61
FHFA (Q3) 4.08
Rig count declines but energy activity
remains robust
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0
20
40
60
80
100
120
140
160
200
300
400
500
600
700
800
900
1000
'00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10 '11 '12
TX rig
Natural gas
Oil price
Note: Natural gas price is multiplied by 10
Rig count,
weekly Nominal price, $
weekly
Exports hit plateau in 2012
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60
80
100
120
140
160
180
200
220
240
2000 2002 2004 2006 2008 2010 2012
Index, SA,
Jan.'00=100
Texas
U.S.
36%
9% 11%
16%
18%
7%
Mexico
Canada
European Union
Asia, excl. China
2012:Q3
17%
17%
21% 11% 3%
10%
21%
ChemicalsComputers & ElectronicsPetroleum and Coal ProductsMachineryAgriculture and FoodTransportation EquipmentOther
2012:Q3
TMOS production index points to
weakness in manufacturing
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-100
-80
-60
-40
-20
0
20
40
60
80
100
Jun-04 Jun-05 Jun-06 Jun-07 Jun-08 Jun-09 Jun-10 Jun-11 Jun-12 Jun-13
January
Index
Current Production
Future Production
General Business Activity
Summary
The Texas economy expanding at a modest pace
Job growth slowed in Q3 and Q4 of 2012
Outpacing the nation
Strong housing recovery
Energy Sector has slowed but remains robust
Manufacturing and exports are pockets of weakness
Downside risk
– Continued fiscal uncertainty
Expect job growth of around 2-3% in 2013
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“Ending Too Big To Fail:
A Program for Financial Reform”
Harvey Rosenblum Executive VP & Director of Research
&
David Luttrell
Senior Economic Analyst
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The views expressed are those of the speaker and should not necessarily be attributed
to the Federal Reserve Bank of Dallas or the Federal Reserve System.
Overarching Theme
A subsidy once given is nearly impossible to take away
Hold this thought…
Realign incentives and restructure the megabanks:
The Proposal for Reform
Puts DISCIPLINE back in MARKET DISCIPLINE, and MARKET DISCIPLINE back in MARKET CAPITALISM
Clearly delineate the boundaries of the federal safety net
Restructure megabanks so that they will be impacted by market and regulatory discipline
Cost of 2007–2009 Financial Crisis
Between $10-20 trillion in costs:
Reduced capacity to respond to the next crisis
Adverse impacts will likely endure for a long time
Insurance “is a system whereby a person who can’t pay, gets another person who can’t pay, to guarantee that he can pay.”
— Charles Dickens, Little Dorritt
– Crippled confidence, lost opportunity, increased uncertainty
– Lost output, reduced wealth, extended unemployment, and extraordinary gov’t intervention programs
– Does not include human misery
Harvey’s 2013 Economic Outlook
Likely another slow growth year
– Closer to 2% than 3%
Post-financial crisis drag continues
– Modest deleveraging: households and banks
– Monetary policy-induced “flush” capital markets
90
92
94
96
98
100
102
104
Index, each District employment peak=100
Employment Remains Far Below Pre-Crisis Peaks, Except in Texas
Dallas is 2.3% above its Aug. ’08 peak
Dallas
Chicago
Atlanta San Francisco
Minneapolis
Kansas City Richmond
Philadelphia
St. Louis Cleveland
New York
Boston U.S.
Uneven and Unhurried Recovery
Over the past 3 years, only the Dallas, San Francisco, Minneapolis, and Cleveland Districts have outpaced the U.S. average pace of job growth
Business loans are on track to regain prior trend around 2019… around when Dodd–Frank is expected to be implemented
At the current pace of GDP per capita growth, it will still be at least another year until households regain their prior level of output (late 2013)
– This pace also makes it impossible to regain prior trend
Choosing the Road to Prosperity: Why We Must End Too Big to Fail – Now
Dallas Fed 2011 Annual Report
Complete Annual Report issue and presentation may be found at: www.dallasfed.org/fed/annual/index.cfm
April 4, 2012
Dallas Fed 2011 Annual Report Follow-Up
“Though it sounds radical, restructuring is a far less drastic solution than quasi-nationalization, as happened in 2008–09.”
Published July 2012 www.dallasfed.org/assets/documents/
fed/annual/2012summer.pdf
Dallas Fed 2011 Annual Report Follow-Up
December 2012 www.dallasfed.org/assets/documents/
fed/annual/2012winter.pdf
November 2012 www.dallasfed.org/assets/documents/
research/staff/staff1203.pdf
Available at: www.dallasfed.org
Dallas Fed 2012 Report
Richard Fisher’s Jan. 16, 2013 Speech
Too Big to Fail
A couple of working definitions:
TBTF = exempt from bankruptcy
Bank resolutions are separate from bankruptcy court
— Smaller banks are not TBTF: FDIC “in on Friday, out by Monday”
“A financial institution so large, interconnected, and/or complex that its demise could substantially damage the financial system and economy if it were allowed to fail”
Three Pillars
Supervisors Rulebook Market Discipline
Without strong market discipline,
this financial edifice collapses
Financial System (Resilience)
Dodd–Frank Doesn’t Get It Right
Dodd-Frank Act (DFA):
Regulators/Supervisors: Usually a step or two behind financial market innovations
Can’t enforce rules that are not easily understood
Long on process, short on results
Has not been simplified and codified quickly
DFA contributes complexity and confusion to regulatory discipline: increases economic uncertainty
— 849 pages; 8,800 pages of regulations; approx. 1/3 finalized!
Market Discipline
Market discipline has been eroded by: Extensions of the federal safety net (implicit and explicit)
Industry consolidation that perpetuates TBTF
Further, DFA does little to embellish or reinvigorate market discipline
Market discipline—restrains a firm’s stakeholders (stockholders, creditors, management) from excessive risk-taking because they are exposed to the firm’s losses.
U.S. Banking Concentration
Megabanks, $250B–$2.3T
(12), 69%
Mod.-sized, >$10B–$250B
(70), 19%
Community banks,
(5,500), 12%
NOTE: Data for commercial banks and bank holding companies as of September 30, 2012. Asset size is based on the total assets
of a U.S. banking organization (holding company, when applicable).
Only 0.2% of
all banking
organizations
account for
nearly 70% of
total industry
assets
Can Fail
Outright?
Speed of
Resolution
Regulatory
Discipline Shareholders
Unsecured
Creditors
Community Banks Yes Weekend Often
significant
Some, often
considerable
Too few to
matter
Regional /
Moderate-Sized
Banks (70)
Yes Few weeks
to 18 months
Significant,
but slow
Significant, but
lagged
Some,
possibly
significant
Megabanks (12) No Never closed
Insufficient,
may be
ineffective
Limited Perverse
Market Discipline from:
Matrix: bank size and complexity v. impact of external discipline
External Discipline Matrix
Small, community banks — Considerable
Moderate-sized banks — The most
Megabanks — Almost none
Externally-Imposed Discipline
“But there ain’t no point in talking When there’s nobody listening” — Rod Stewart, Young Turks
Banks won’t listen if they are supersized beyond the reach of supervisors and stakeholders
Largest U.S. BHCs credit rating uplift of more than 2 notches
Lowers funding costs by a full percentage point
BIS 2012 Annual Report, p. 75–6:
TBTF: Unfair Implicit Subsidies
Current implicit TBTF global subsidy is $300bn per year
Andrew Haldane, “On Being the Right Size,” Oct. 25, 2012:
Note: All U.S. BHCs reported aggregate 2011 earnings of $108bn
1. TBTF banks operate with limited external discipline
2. Government policy subsidizes TBTF banks to grow and take excessive risks
RECAP: TBTF Advantages
DFA doesn’t get it done: Ending TBTF necessitates downsizing largest banks
If Dodd–Frank Doesn’t End TBTF,
What Will?
No easy solutions,
No good ones,
Need to choose the least worst
Financial Holding Co. (FHC) Structure
Bank Holding Co. (BHC)
Finance Co.
(including Real Estate sub.)
Financial Holding Company
(FHC)
Other sub.s
Nonbank subsidiaries
(including Investment Bank)
Commercial Bank
Securities subsidiary
(Broker-dealers)
Insurance sub.
Other sub.s
Clearly Define Where the Safety Net Begins and Ends
Safety net SHOULD NOT cover shadow banking activities
NO GOV’T SUBSIDY: NONE. Creditors should know this with certainty
Counterparties should sign a disclosure that acknowledges this
Safety net BEGINS and ENDS here!
Banks are special: Clear and strong safety net for traditional depository institutions
Deposit insurance
Discount window
Commercial Bank
Shadow banking affiliates
Sample: Simple Disclosure
“WARNING: Conducting business with this affiliate of the bank holding company carries NO federal deposit insurance or other federal government protection or guarantees.
I, , fully understand that in conducting business with banking affiliate, I have NO federal deposit insurance or other federal government protection or guarantees. None.”
Important step: Removes implicit subsidy from BHC and affiliated shadow banking operations
Will It Work? Yes, But Too Slowly
Restructuring TBTF banking organizations necessary to end TBTF, level the playing field for all commercial banks
Simplicity and clarity: There are no government safety nets outside of regulated commercial banking
Gets incentives right
But may work too slowly to avoid the next crisis?
Resize to where market and regulatory discipline work
— Full range of financial services will still be provided, but by refocused and unsubsidized firms
Reinforce the Market
The market is already moving this direction – Rewarding reduced complexity
These recommendations are not actually that radical!
0.8
1.6
0.0
0.5
1.0
1.5
2.0
Super big & complex Big, but not as complex
Average price-to-tangible book value ratio, Oct. 2012
Wells Fargo, U.S. Bancorp, BB&T, SunTrust, Fifth Third
JP Morgan, BofA, Citigroup, Goldman, Morgan Stanley
We must end TBTF in order to:
REMINDER: Why Is This Necessary?
Reintroduce market forces instead of complex rules — Level playing field; minimize uncertainty and unfairness
Avert the cost burden of next crisis (borne by millions of taxpayers) v. benefits of TBTF status quo (accruing to concentrated cohort)
Change the “Bailout” v. “End-of-the-world” decision-making paradigm
Monetary policy needs to focus on inflation and the macroeconomy, not propping up TBTF banks
Benefits of Dallas Fed’s Modest Proposal
End government ownership and management of banks
Treat all financial institutions equally
• Level the playing field: equal discipline
• All are Too Small to Save (TSTS)
TBTF hopefully removed
Conclusion
We have accidentally stumbled into a place we never wanted to be
“Relax said the night man We are programmed to receive You can checkout anytime you like But you can never leave!”
— Don Felder, Don Henley, and Glenn Frey, Hotel California
Restoring market discipline is the key
We have to find the passage back to the place we were before
BUT need to avoid Hotel California trap:
