Mr. Hoenig Goes to Washington

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Mr. Hoenig Goes to Washington

By SIMON JOHNSON

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Thomas Hoenig, the former president of the Federal Reserve Bank of Kansas City, has long been a strong voice for financial sector reform along sensible lines. Within the official sector, he has spoken loudest and clearest on the most important defining issue: “Too big to fail” is simply too big. And last week he took a major step toward a more prominent role, when he was nominated by President Obama to be vice chairman of the Federal Deposit Insurance Corporation.

The F.D.I.C. is not as powerful as the Fed, but in our current financial arrangements, it does play a critical role. The Dodd-Frank legislation has its weaknesses, but it gives the F.D.I.C. two important powers.

First, with regard to big banks, the F.D.I.C. can help force the creation of credible “living wills” — explaining how the bank can be wound down if necessary. If such wills are not plausible then, in principle, the F.D.I.C. could force simplification or divestiture of some activities. Second, the F.D.I.C. is now in charge of “resolution” for mega-banks, i.e., actually closing them down and apportioning losses in the event of failure.

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In the current mix of Washington-based policy makers, Mr. Hoenig would be a great addition. He spoke out early and often against “too big to fail” banks. In early 2009, his paper “Too Big Has Failed” became an instant classic. It is worth reading again because it contains a number of forward-looking statements that remain important. Perhaps the most relevant for his F.D.I.C. role:

Some are now claiming that public authorities do not have the expertise and capacity to take over and run a “too big to fail” institution. They contend that such takeovers would destroy a firm’s inherent value, give talented employees a reason to leave, cause further financial panic and require many years for the restructuring process. We should ask, though, why would anyone assume we are better off leaving an institution under the control of failing managers, dealing with the large volume of “toxic” assets they created and coping with a raft of politically imposed controls that would be placed on their operations?

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