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Why It's Time to Abolish the Fed


Regulators only act in hindsight.

The Federal Reserve Bank of Cleveland is proposing a 3-tiered system for regulating systemically important financial institutions (SIFI).

Tier 1 would include high-risk institutions, such as large, interstate banks and multi-state insurance companies.

Tier 2 would include moderately complex financial institutions, such as larger regional banks.

Tier 3 would include non-complex financial institutions, such as community banks.

Each would receive varying degrees of oversight and regulation. In the accompanying video, the author claims: "Really bad drawings…real simple explanations."

Drawing Board: How To Address SIFI

SIFI Framework

1. Size:

As a starting point for a size-based definition, a financial firm would be considered systemically important if it accounts for at least 10% of the activities or assets of a principal financial sector or financial market or 5% of total financial market activities or assets.

2. Contagion:

A financial institution would be considered systemically important if its failure could result in the collapse or freezing up of one or more important financial markets.

3. Correlation:

Correlation, as a source of systemic importance, is also known as the "too many to fail" problem.

4. Concentration:

Concentration has 2 important aspects: the size of the firm's activities relative to the contestability of the market. That is, concentration is less likely to make a financial institution systemically important if, other things being equal, the activities of a distressed institution can easily be assumed by a new entrant into the market or by the expansion of an incumbent firm's activities. Hence, it's logical to adjust concentration thresholds to account for contestability.

5. Conditions/Context:

This pertains to the fragility of the markets at the time, for example: New York Fed's reluctance to allow the failure of Long-Term Capital Management resulted largely from the fragility of financial markets at that time -- due to the Southeast Asian currency crises and the Russian default. This might explain, in part, why LTCM was treated as systemically important and Amaranth (which was more than twice as big) wasn't.

Another example would be intervention to prevent the bankruptcy of Bear Stearns by merging it (with assistance) into JPMorgan Chase (JPM) in early 2008, whereas Drexel Burnham Lambert was allowed to enter bankruptcy in early 1990. Firms that might be made systemically important by conditions/context are probably the most difficult to identify in advance.

Preventing the Last Crisis

The video is cute and will likely be well received. However, I ask: To what extent is all of this regulation attempting to prevent the last crisis?

Moreover, please recall that 18 months ago, Bernanke thought housing would rebound in 2008, the housing problems were contained to subprime, and there was no national bubble to burst.

FHA , The Next Fannie Mae

In spite of the now-known problems with leverage at Fannie, Freddie (FRE), and American International Group (AIG), and in the wake of the blowup of Lehman and Bear Stearns, and the near blowup of Citigroup (C), Bank of America (BAC), and Wells Fargo (WFC), etc., no one is acting to rein in the FHA.
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