Walker Todd is an adjunct scholar at the
Cato Institute's new
Center for Monetary Financial Alternatives, and an
Institute grantee. He is also an economic consultant with 20 years' experience at the
Federal Reserve Bank of
New York and the
Federal Reseve
Bank of
Cleveland.
So to say he has a broad historic view of today's global financial conditions would be an understatement. In
Todd's view, an opportunity to restructure the banking system along less dangerously systemic lines was lost when Dodd-Frank was adopted. One of the biggest flaws, in Todd's view, was the reluctance to stress test the banks properly and "get real" as far as the underlying value of their assets were concerned.
In Todd's view, we got a very bank-friendly bailout which resolved nothing, and in the interview he contrasts this to the period during the
Great Depression, when we seemed to know better. The original stress test was developed during the bank holiday, March 4-12, 1933. It is described in
Jones (1951, pp. 22-23, 27-30).
Jesse Jones already was a director of the
RFC and became its head with the coming of the
Roosevelt Administration.
During the bank holiday, the RFC and other federal and state bank examining authorities simultaneously examined the nation's banks and divided them into three categories,
A, B, and C. A banks were considered sound; B banks had lost most of their capital but still could pay off depositors in full; C banks had lost all their capital and also could not pay depositors in full at fair market value. A banks were reopened promptly; B banks were reopened as soon as they either raised new capital or made deals with the RFC; C banks were placed into conservatorship to be dealt with later.
Banks in conservatorship, however, were allowed to receive new deposits as long as they were segregated from old deposits (Todd,
1993 and 2008).
Asset valuations were at fair market value. It was not until
1938 that the
Federal Reserve forced the other regulators to accede to historic cost accounting for banks' assets. The 1938 examination and accounting change was made to encourage new lending and to enable private investors to acquire failed banks' assets from the federal authorities without immediate writedowns of their value .
By the end of the bank holiday week, the RFC's directors decided to pursue a policy of making loans (buying preferred stock with convertible warrants) in banks whose assets "appeared to equal 90 percent of their total deposits and other liabilities exclusive of capital" (Jones 1951, pp. 27-28). The RFC's aim was "to put pressure on the banks' stockholders and customers and the people in their vicinities to get them interested in putting capital in and owning their own banks" instead of having the RFC own them. Banks failing the 90 percent test were sent to the "hospital" (category C above).
By
December 1933, Jones estimated that around 2,
000 of the 12,000 remaining banks (there had been 17,000 before the March holiday) were below the RFC's 90 percent threshold, with average asset values in that pool not quite up to 75 percent. With the tacit approval of the
Senate Banking Committee, one of whose members was
Carter Glass of
Virginia, an original
House sponsor of the
Federal Reserve Act of 1913, Jones made a bargain with
Treasury Secretary Henry Morgenthau.
Jones promised that, if Morgenthau would certify the 2,000 unresolved banks as solvent on
January 1, 1934, when the new federal deposit insurance system was to take effect, Jones and the RFC would see to it that the banks in fact would be solvent within six months. Essentially, Jones contemplated making larger loans to those banks, filling in the gaps that remained between the
75 percent and 90 percent valuation thresholds. Over the next six months, the RFC recruited $
180 million more of private capital investments in those banks to reduce the valuation gap of up to 15 percent gap that it was financing.
The new private investments were subordinated to the RFC's claims in the capital structures of the banks receiving that assistance (Jones 1951, pp. 28-30).
The upshot was that we had a financial system that was fully cleansed of its rot and the stage was set for a period of comparative financial stability in the decades ahead.
Does anybody seriously think that Dodd-Frank achieved anything close that?
Listen to Todd and you'll get the likely answer.
- published: 22 Jan 2016
- views: 1063