The head of the Federal Reserve Bank of Minneapolis released an ambitious plan Wednesday designed to head off another financial crisis triggered by the collapse of big banking entities. The central idea is to impose financial stability requirements, which could pressure large banks to break themselves into smaller pieces.
The "Minneapolis Plan" would reduce the risk of another government bailout in the next century to less than 10 percent, Minneapolis Fed President Neel Kashkari said in a prepared speech at the Economic Club of New York on Wednesday morning.
"The devastation from the financial crisis, we're still paying (for) it, not just in terms of lost jobs and outlook, but I look at the polarization in the country today and I feel like it's a direct outcome of the financial crisis," Kashkari said. "If we can avoid these types of scenarios, my gut tells me it's worth it to pay some insurance for that."
During the Bush administration Kashkari oversaw the Troubled Assets Relief Program (TARP), the $700 billion federal bailout fund set up to prevent the financial system's collapse.
His proposal would require that banks with assets over $250 billion must maintain higher amounts of what's called common equity capital. The goal is to increase the institutions' ability to absorb unexpected losses. Banks that the U.S. Treasury Department deems as systemically important to the economy would be subject to increasingly higher equity requirements, eventually up to 38 percent of assets.
The result of these new regulations could be that banks decide it's in their economic interest to break themselves up, Kashkari said.
"We believe the threat of these massive increases in capital will provide strong incentives for the largest banks to restructure themselves so that they are no longer systemically important," Kashkari said. "Any bank that remains (too big to fail) will have so much capital that it virtually cannot fail."
The plan also addresses so-called "shadow banks," which operate with fewer regulatory restrictions than banks. Those with over $50 billion in assets would be subject to higher tax rates on borrowing. Kashkari said this would prevent more risky financial activity from shifting over to these less-regulated institutions.
The proposal would also lift some regulations on smaller and community banks.
The Minneapolis Fed report includes a benefit cost analysis as well. If the entire plan is adopted, the cost of new regulations could equal up to 41 percent of the gross domestic product. On the other hand, the cost of another banking crisis is pegged at 158 percent of the country's gross domestic product, or roughly $28 trillion.
Kashkari said during the speech that if the new regulations prevent even one financial crisis, they will have paid for themselves multiples times over.
"We cannot make the risk of a financial crisis zero, and safety isn't free," Kashkari said. "Ultimately, the public has to decide how much safety they want in order to protect society from future financial crises and what price they are willing to pay for that safety."
The Minneapolis Fed hosted four separate policy symposiums on the issue before issuing its report. The plan will now pen to a 60-day comment period. In order to take effect, the plan would need to pass a Republican Congress. And financial sector stocks have risen since the election on bets that Congress will relax, not tighten financial regulations.
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