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FDIC Vice-Chair Thomas Hoenig:
Remove the Safety Net
from Non-Bank Activities,
Return to Glass-Steagall Framework

January 17, 2013 (EIRNS)—This release was issued today by the Lyndon LaRouche Political Action Committee.

Thomas M. Hoenig, Vice-Chairman of the Federal Deposit Insurance Corporation, urged in an article today in American Banker newsletter, that the problem of "too big to fail" banks be solved by removing the "safety net" of Federal insurance from non-bank activities, since without it, the largest banks will shrink drastically, as investors demand that these banks hold stronger assets.

Hoenig writes,

"'For decades the principle of limited subsidy was understood and practiced. The Glass-Steagall Act kept commercial banks and the government safety net separate from investment banking and broker-dealer activities. Just as importantly, investment banks were kept separate from the payments system and from funding their activies with insured deposits.' This system served the United States from the Great Depression until 1999, when the passage of the Gramm-Leach-Blily Act officially ended the separation of activies, Hoenig writes.

There have been calls to break up the largest banks, and place the nonbank broker-dealer activities in separate companies to compete for public investment. Would they remain "too big to fail" if that were done? Hoenig answers, "The short answer is no. Structured correctly and without a government backstop, the market would demand stronger capital and safer asset growth. This in turn would enhance the ability to place them into bankruptcy instead of the arms of the taxpayer, should they run into trouble."

The safety net is essential to meeting the liquidity demands of the payments and clearing system, Hoenig explains. But, it creates a "moral hazard," because creditors worry less about getting their money back and a firm's financial condition — a problem which intensifies as firms become larger and add other activities that enjoy the safety net:

"Subsidizing noncore banking activities such as underwriting, proprietary trading, market making, and derivatives encourages firms to bring these business lines onto their balance sheets using more debt, most of which is very short term. The effect is to make the financial system increasingly fragile, and it becomes proportionately more difficult to allow these firms to fail."

"Thus, to realistically address the problem of too-big-to-fail, these activities must again be separated. Commercial banking companies should be confined to operating the payments system and engaging in lending and traditional activities that follow from this basic role... At the same time, placing broker-dealer activities outside of the safety net will reduce the direct risk to the taxpayer and lower the multibillion- dollar subsidy that economists now estimate these activities currently enjoy," writes Hoenig. All other activities may continue by broker-dealers, but firms that run into trouble would be much more likely to be resolved through bankruptcy, without a big impact on the economy, as when Drexel-Burnham failed in 1990."

American Banker is a New York-based daily trade newspaper covering the financial services sector, with 50 reporters in 6 cities. It is published in print 4 days a week, and online only on Friday. Its website receives 560,000 hits per month.