By Deborah Lynn Blumberg Of DOW JONES NEWSWIRES
Regulators must be firm about limiting the power of large financial institutions in order to ensure a stable financial system, Dallas Federal Reserve President
Fisher, a nonvoting member of the Federal Open Market Committee this year, urged policymakers working on changes to the U.S. financial system to act swiftly and without hesitation to address the "too big to fail" issue. He was delivering prepared remarks in Dallas before a group from the Southwestern Graduate School of Banking.
"Let me make my sentiments clear. It is my view that, by propping up deeply troubled big banks, authorities have eroded market discipline in the financial system," Fisher said. And continuing to bolster big banks is dangerous, he said. "It is not difficult to see where this dynamic leads--to more pronounced financial cycles and repeated crises."
Ending the notion of too big to fail "is certainly a necessary part of any regulatory reform effort that could succeed in creating a stable financial system," Fisher said, and "the most sound response of all."
While a globalized, interconnected marketplace does need big financial institutions, he said, it does not need a few huge institutions capable of bringing down the very system they claim to serve.
The central banker said that in thinking about ways to resolve the too-big-to-fail issue, he is a skeptic of regulation alone. It is highly unlikely that big commercial banking companies can be effectively regulated, he said, even after reform were put into place.
Fisher is also doubtful about the effectiveness of an approach in which regulators draw up guidelines on how to proceed in the case of a big bank failure. Current proposed regulations allow for too much "wiggle room" for the 'too big to fail issue', Fisher said.
Instead, he favors an approach that would shrink big banks by capping their size or breaking them up, and that should be done soon.
"The longer authorities delay the process, the more engrained behemoth financial institutions become; the more engrained they become, the less extricable they are," he said. "And so the debilitating disease of TBTF spreads. What appears 'vital' becomes 'viral' and grows ever more threatening to financial stability and economic stability."
In its latest version, the financial regulatory overhaul bill has left regulators with the power to impose greater restrictions on firms without a credible living will, or to plan for a rapid resolution should the bank fail. Fisher said that regulators should freely use this broad authority "to commit credibly to resolution with creditor losses by reducing big banks' size and interconnectedness."
He dismissed arguments against breaking up big banks, pointing to the considerable diversity and performance among smaller banks. Smaller banks appear to have succumbed less to the herd-like mentality that brought their larger peers to their knees, Fisher said. And as for the possibility of a liquidity crisis among small banks reminiscent of what occurred during the Depression, Fisher pointed to federal deposit insurance, which protects deposits for funding, and noted the Fed's prowess in dealing with liquidity disruptions.
In other remarks, Fisher said the European Union is falling more into the regulate-and-resolve camp, rather than the "shrink 'em camp."
He also said the Fed is best suited for the responsibility of regulating banking organizations across the spectrum, from community and regional banks to money center banks to thrift holding companies.
-By Deborah Lynn Blumberg, Dow Jones Newswires; 212-416-2206; deborah.blumberg@dowjones.com
Copyright (c) 2010 Dow Jones & Company, Inc.
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