Better Ways to Prevent Problems With TBTF Banks

in In the News
June 5th, 2014

Mandating an added layer of preferred stock for banks can serve the same purpose as Prof. Calomiris’s proposed CoCo mandate.

From The Wall Street Journal
Letters
June 4, 2014

 

Regarding Charles W. Calomiris’s “A Better Solution for Too-Big-to-Fail Banks” (op-ed, May 30): I originally proposed what are now called CoCos—debt that forcibly converts into equity on the downside to stave off or prevent insolvency—to Prof. Hayne Leland of the Haas School of Business in 1993.

Mandating an added layer of preferred stock for banks—as supplemental to, and not a part of, existing equity requirements—can serve the same purpose as Prof. Calomiris’s proposed CoCo mandate, and without CoCos holders who might short. Passing a law requiring a 100% dividend received deduction for preferred dividends, rather than the typical 70% today, at least for banks, shadow banks and insurers, could reduce financial-sector resistance to a gradually implemented 10% preferred stock-to-asset mandate, in excess of today’s equity requirements.

While an additional 10% mandate for either CoCos, as Prof. Calomiris proposes, or preference stock, will shore up confidence in financial institutions and insurance companies, and will reduce the incidence of liquidity crises, these safeguards do not improve liquidity itself, meaning that such measures must not reduce public will, or even the perception of such will, to provide liquidity as and when needed.

Of course, our zero-tolerance policy must be toward illiquidity that may inspire a run or a chain reaction, and not toward bailouts. However, bailouts should always include both an 80% minimum reduction in common dividends until the bailout is repaid, as well as a significant upside for the bailout lender, as a discipline.

Michael P. Ross, Ph.D., CFA

New York

A more stringent systemic approach is needed than comfortable 10% converts. A giant can become illiquid faster that a mere 120 days. A much higher capital requirement, deeper restrictions on contingent liabilities and off-balance-sheet promises-to-pay may well be the next line of inquiry.

David Fairchild Johannesen

Los Altos, Calif.

The sooner we learn that the essence of the TBTF problem is the taxpayer subsidized funding of each TBTF bank, the sooner we can move on to real solutions rather than relying on the Rube Goldberg menu of solutions that includes CoCos and beggar-thy-neighbor multibillion dollar fines and convictions.

Banks should be required to book as a reserve that part of their retained earnings that comes from the TBTF subsidy (about $70 billion annually, IMF’s head Christine Lagarde said last week). Let that reserve accrete year over year and monetize it only in connection with asset sales and divestitures. Then watch as market discipline forces the right-sizing of these unruly institutions.

A bill in Congress to do this, H.R. 2266 also known as the Subsidy Reserve Plan, is a reasoned, market-driven approach to the TBTF problem. No more fighting complexity with complexity, it’s time for simpler, direct solutions. The GAO will soon release its own report measuring the scale of the TBTF subsidy.

The late Fed Chairman William McChesney Martin famously described the Fed’s monetary role vis-à-vis the economy as being one of “removing the punch bowl” (raising interest rates) just as things were heating up. It’s time to extend that maxim to the Fed’s role as a banking regulator where the TBTF subsidy is the punch bowl.

Prof. Cornelius Hurley

Director

Boston University Center for Finance, Law & Policy

Boston

 

Read the letters at: online.wsj.com