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Choosing the Road to Prosperity
Why We Must End Too Big to Fail—Now

2011 ANNUAL REPORT
FEDERAL RESERVE BANK OF DALLAS

The too-big-to-fail institutions that amplified and prolonged
the recent financial crisis remain a hindrance to full
economic recovery and to the very ideal of American
capitalism. It is imperative that we end TBTF.

Contents
Letter from the President 1
Choosing the Road to Prosperity 2
Year in Review 24
Senior Management, Officers and Advisory Councils 26
Boards of Directors 28
Financial/Audit 32

Letter from the

President

I

f you are running one of the “too-bigto-fail” (TBTF) banks—alternatively
known as “systemically important
financial institutions,” or SIFIs—I doubt you
are going to like what you read in this annual
report essay written by Harvey Rosenblum, the
head of the Dallas Fed’s Research Department,
a highly regarded Federal Reserve veteran of 40
years and the former president of the National
Association for Business Economics.
Memory fades with the passage of time.
Yet it is important to recall that it was in recognition of the precarious position in which the
TBTF banks and SIFIs placed our economy in
2008 that the U.S. Congress passed into law the
Dodd–Frank Wall Street Reform and Consumer
Protection Act (Dodd–Frank). While the act
established a number of new macroprudential
features to help promote financial stability, its
overarching purpose, as stated unambiguously
in its preamble, is ending TBTF.
However, Dodd–Frank does not eradicate TBTF. Indeed, it is our view at the Dallas
Fed that it may actually perpetuate an already
dangerous trend of increasing banking industry
concentration. More than half of banking
industry assets are on the books of just five
institutions. The top 10 banks now account
for 61 percent of commercial banking assets,
substantially more than the 26 percent of only
20 years ago; their combined assets equate to
half of our nation’s GDP. Further, as Rosenblum
argues in his essay, there are signs that Dodd–
Frank’s complexity and opaqueness may even

be working against the economic recovery.
In addition to remaining a lingering threat
to financial stability, these megabanks significantly hamper the Federal Reserve’s ability to
properly conduct monetary policy. They were a
primary culprit in magnifying the financial crisis,
and their presence continues to play an important role in prolonging our economic malaise.
There are good reasons why this recovery
has remained frustratingly slow compared with
periods following previous recessions, and I
believe it has very little to do with the Federal
Reserve. Since the onset of the Great Recession,
we have undertaken a number of initiatives—
some orthodox, some not—to revive and
kick-start the economy. As I like to say, we’ve
filled the tank with plenty of cheap, high-octane
gasoline. But as any mechanic can tell you, it
takes more than just gas to propel a car.
The lackluster nature of the recovery is
certainly the byproduct of the debt-infused
boom that preceded the Great Recession, as
is the excessive uncertainty surrounding the
actions—or rather, inactions—of our fiscal authorities in Washington. But to borrow an analogy Rosenblum crafted, if there is sludge on the
crankshaft—in the form of losses and bad loans
on the balance sheets of the TBTF banks—then
the bank-capital linkage that greases the engine
of monetary policy does not function properly to
drive the real economy. No amount of liquidity
provided by the Federal Reserve can change this.
Perhaps the most damaging effect of propagating TBTF is the erosion of faith in American

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capitalism. Diverse groups ranging from the
Occupy Wall Street movement to the Tea Party
argue that government-assisted bailouts of
reckless financial institutions are sociologically
and politically offensive. From an economic
perspective, these bailouts are certainly harmful
to the efficient workings of the market.
I encourage you to read the following
essay. The TBTF institutions that amplified and
prolonged the recent financial crisis remain a
hindrance to full economic recovery and to the
very ideal of American capitalism. It is imperative that we end TBTF. In my view, downsizing
the behemoths over time into institutions that
can be prudently managed and regulated across
borders is the appropriate policy response. Only
then can the process of “creative destruction”—
which America has perfected and practiced
with such effectiveness that it led our country
to unprecedented economic achievement—
work its wonders in the financial sector, just as
it does elsewhere in our economy. Only then
will we have a financial system fit and proper
for serving as the lubricant for an economy as
dynamic as that of the United States.

Richard W. Fisher

As a nation, we face a distinct choice. We can perpetuate too big to fail, with its inequities and dangers, or we
can end it. Eliminating TBTF won’t be easy, but the vitality
of our capitalist system and the long-term prosperity it
produces hang in the balance.

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Choosing the Road to Prosperity
Why We Must End Too Big to Fail—Now
by Harvey Rosenblum

M

ore than three years after a crippling financial crisis, the American economy
still struggles. Growth sputters. Job creation lags. Unemployment remains high.
Housing prices languish. Stock markets gyrate. Headlines bring reports of a

shrinking middle class and news about governments stumbling toward bankruptcy, at
home and abroad.
Ordinary Americans have every right to feel anxious, uncertain and angry. They have
every right to wonder what happened to an economy that once delivered steady progress.
They have every right to question whether policymakers know the way back to normalcy.
American workers and taxpayers want a broad-based recovery that restores confidence. Equally important, they seek assurance that the causes of the financial crisis have
been dealt with, so a similar breakdown won’t impede the flow of economic activity.
The road back to prosperity will require reform of the financial sector. In particular, a new roadmap must find ways around the potential hazards posed by the
financial institutions that the government not all that long ago deemed “too big to
fail”—or TBTF, for short.
In 2010, Congress enacted a sweeping, new regulatory framework that attempts
to address TBTF. While commendable in some ways, the new law may not prevent the
biggest financial institutions from taking excessive risk or growing ever bigger.
TBTF institutions were at the center of the financial crisis and the sluggish recovery that followed. If allowed to remain unchecked, these entities will continue posing
a clear and present danger to the U.S. economy.
As a nation, we face a distinct choice. We can perpetuate TBTF, with its inequities
and dangers, or we can end it. Eliminating TBTF won’t be easy, but the vitality of our
capitalist system and the long-term prosperity it produces hang in the balance.

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When competition declines, incentives often turn perverse, and self-interest can turn malevolent. That’s what
happened in the years before the financial crisis.

Flaws, Frailties and Foibles

When calamities don’t occur, it’s huThe financial crisis arose from failures man nature to stop worrying. The world
seems less risky.
of the banking, regulatory and political
Moral hazard reinforces complacency.
systems. However, focusing on faceless
Moral
hazard describes the danger that
institutions glosses over the fundamenprotection against losses encourages riskier
tal fact that human beings, with all their
flaws, frailties and foibles, were behind the behavior. Government rescues of troubled
financial institutions encourage banks and
tumultuous events that few saw coming
their creditors to take greater risks, knowand that quickly spiraled out of control.
ing they’ll reap the rewards if things turn
out well, but will be shielded from losses if
Complacency
Good times breed complacency—not things sour.
In the run-up to the crisis of 2008, the
right away, of course, but over time as
public sector grew complacent and relaxed
memories of past setbacks fade. In 1983,
the financial system’s constraints, explicitly
the U.S. entered a 25-year span disrupted
in law and implicitly in enforcement. Adby only two brief, shallow downturns, acditionally, government felt secure enough
counting for just 5 percent of that period
in prosperity to pursue social engineering
(Exhibit 1). The economy performed
goals—most notably, expanding home
unusually well, with strong growth, low
ownership among low-income families.
unemployment and stable prices.
At the same time, the private sector
This period of unusual stability and
also became complacent, downplaying
prosperity has been dubbed the Great
Moderation, a respite from the usual tumult the risks of borrowing and lending. For
example, the traditional guideline of 20
of a vibrant capitalist economy. Before the
Federal Reserve’s founding in 1913, recession percent down payment for the purchase
of a home kept slipping toward zero, esheld the economy in its grip 48 percent of
pecially among lightly regulated mortgage
the time. In the nearly 100 years since the
companies. More money went to those
Fed’s creation, the economy has been in
with less ability to repay.1
recession about 21 percent of the time.

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Greed
You need not be a reader of Adam
Smith to know the power of self-interest—the human desire for material gain.
Capitalism couldn’t operate without it.
Most of the time, competition and the rule
of law provide market discipline that keeps
self-interest in check and steers it toward
the social good of producing more of what
consumers want at lower prices.
When competition declines, incentives often turn perverse, and self-interest
can turn malevolent. That’s what happened
in the years before the financial crisis. New
technologies and business practices reduced
lenders’ “skin in the game”—for example,
consider how lenders, instead of retaining
the mortgages they made, adopted the
new originate-to-distribute model, allowing
them to pocket huge fees for making loans,
packaging them into securities and selling
them to investors. Credit default swaps fed
the mania for easy money by opening a
casino of sorts, where investors placed bets
on—and a few financial institutions sold
protection on—companies’ creditworthiness.
Greed led innovative legal minds to
push the boundaries of financial integrity

with off-balance-sheet entities and other accounting expedients. Practices that weren’t
necessarily illegal were certainly misleading—at least that’s the conclusion of many
postcrisis investigations.2
Complicity
We admire success. When everybody’s
making money, we’re eager to go along for
the ride—even in the face of a suspicion
that something may be amiss. Before the
financial crisis, for example, investors relied
heavily on the credit-rating companies that
gave a green light to new, highly complex
financial products that hadn’t been tested
under duress. The agencies bestowed their
top rating to securities backed by high-risk
assets—most notably mortgages with small
down payments and little documentation
of the borrowers’ income and employment.
Billions of dollars of these securities were
later downgraded to “junk” status.
Complicity extended to the public
sector. The Fed kept interest rates too low
for too long, contributing to the speculative binge in housing and pushing investors
toward higher yields in riskier markets. Congress pushed Fannie Mae and Freddie Mac,
the de facto government-backed mortgage

Exhibit 1
Reduced Time Spent in Recession

Time spent in recession (percent)

Time spent in recession, pre-Fed vs. post (percent)

50

60

45

48

40

40

38

37

35

21

20

30
0

25
20

16

1857–1914

1915–2011

17

15
10

5

5
0
1915–1938

1939–1960

1961–1982

SOURCE: National Bureau of Economic Research.

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1983–2007

2008–2011

Concentration amplified the speed and breadth of the
subsequent damage to the banking sector and the
economy as a whole.

Exhibit 2
U.S. Banking Concentration Increased Dramatically

Assets as a percentage of total industry assets

1970

2010
Top 5 banks

12,500 smaller
banks

5,700
smaller banks

17%

Top 5 banks

16%

46%

52%
37%

32%

95 large and
medium-sized
banks

NOTE: Assets were calculated using the regulatory high holder or top holder for a bank and summing assets for all the
banks with the same top holder to get an estimate of organization-level bank assets.
SOURCES: Reports of Condition and Income, Federal Financial Institutions Examination Council; National Information
Center, Federal Reserve System.

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giants, to become the largest buyers of
these specious mortgage products.
Hindsight leaves us wondering what financial gurus and policymakers could have
been thinking. But complicity presupposes
a willful blindness—we see what we want to
see or what life’s experiences condition us to
see. Why spoil the party when the economy
is growing and more people are employed?
Imagine the political storms and public
ridicule that would sweep over anyone who
tried!
Exuberance
Easy money leads to a giddy selfdelusion—it’s human nature. A contagious
divorce from reality lies behind many of history’s great speculative episodes, such as the
Dutch tulip mania of 1637 and the South
Sea bubble of 1720. Closer to home in time
and space, exuberance fueled the Texas oil
boom of the early 1980s. In the first decade
of this century, it fed the illusion that housing prices could rise forever.
In the run-up to the financial crisis,
the certainty of rising housing prices
convinced some homebuyers that highrisk mortgages, with little or no equity,
weren’t that risky. It induced consumers

to borrow on rising home prices to pay for
new cars, their children’s education or a
long-hoped-for vacation. Prudence would
have meant sitting out the dance; buying
into the exuberance gave people what they
wanted—at least for a while.
All booms end up busts. Then comes
the sad refrain of regret: How could we
have been so foolish?
Concentration
In the financial crisis, the human traits of
complacency, greed, complicity and exuberance were intertwined with concentration,
the result of businesses’ natural desire to
grow into a bigger, more important and
dominant force in their industries. Concentration amplified the speed and breadth
of the subsequent damage to the banking
sector and the economy as a whole.
The biggest U.S. banks have gotten a
lot bigger. Since the early 1970s, the share
of banking industry assets controlled by
the five largest U.S. institutions has more
than tripled to 52 percent from 17 percent
(Exhibit 2).
Mammoth institutions were built on a
foundation of leverage, sometimes misleading regulators and investors through the

use of off-balance-sheet financing.3 Equity’s
share of assets dwindled as banks borrowed
to the hilt to chase the easy profits in new,
complex and risky financial instruments.
Their balance sheets deteriorated—too little
capital, too much debt, too much risk.
The troubles weren’t always apparent.
Financial institutions kept marking assets
on their books at acquisition cost and
sometimes higher values if their proprietary
models could support such valuations.
These accounting expedients allowed them
to claim they were healthy—until they
weren’t. Write-downs were later revised by
several orders of magnitude to acknowledge
mounting problems.
With size came complexity. Many big
banks stretched their operations to include
proprietary trading and hedge fund investments. They spread their reach into dozens
of countries as financial markets globalized.
Complexity magnifies the opportunities
for obfuscation. Top management may not
have known all of what was going on—particularly the exposure to risk. Regulators
didn’t have the time, manpower and other
resources to oversee the biggest banks’ vast
operations and ferret out the problems that
might be buried in financial footnotes or

legal boilerplate.
These large, complex financial institutions aggressively pursued profits in the
overheated markets for subprime mortgages and related securities. They pushed
the limits of regulatory ambiguity and lax
enforcement. They carried greater risk and
overestimated their ability to manage it.
In some cases, top management groped
around in the dark because accounting and
monitoring systems didn’t keep pace with
the expanding enterprises.

Blowing a Gasket
In normal times, flows of money and
credit keep the economy humming. A
healthy financial system facilitates payments
and transactions by businesses and consumers. It allocates capital to competing investments. It values assets. It prices risk. For the
most part, we take the financial system’s
routine workings for granted—until the machinery blows a gasket. Then we scramble to
fix it, so the economy can return to the fast
lane.
In 2007, the nation’s biggest investment and commercial banks were
among the first to take huge write-offs on
mortgage-backed securities (Exhibit 3).
(continued on page 11)

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Exhibit 3
Employment Plummets as Financial System Implodes
Selected Timeline, 2007–2010

Trouble starts with shadow banks

➠

Crisis spreads to larger shadow/investment banks

➠

Commercial banks are affected

➠

Smaller banks struggle amid a mixed recovery

300
Investment banks
acquired by largest
commercial banks
with government assistance: Bear Stearns
(3/08); Merrill Lynch
(1/09)

Month over month change in private nonfarm payrolls (thousands)

100

Small banks face rising uncertainty about compliance
costs, unknown implementation of complicated new
regulations and anemic loan demand

0
Monoline insurers
downgraded (6/08)

–100

Bank/thrift failures:
IndyMac (7/08); Washington
Mutual (9/08)

Losses spread to
investors in subprime
mortgage-backed securities; Bear Stearns
fights unsuccessfully
to save two ailing
hedge funds (6/07)

–300

Subprime
mortgage-related
and leveraged loan
losses mount amid
serial restatements of
write-downs; execs
at Citi and Merrill
Lynch step down
(07:Q4)

Subprime mortgage
lenders show losses
and some go bankrupt:
New Century Financial
(4/07)

–500

Government intervention – Citi and Bank
of America receive
government guarantees;
troubled asset relief
program (TARP) funds
released, restrictions on
exec pay, “stress tests”
introduced; Fed pushes
policy rate near zero,
creates special liquidity
and credit facilities and
introduces largescale asset purchases
(08:Q4–09:Q1)

Nationalization of
systemically important
mortgage-lending
institutions: Northern
Rock (2/08); Fannie
Mae and Freddie Mac
(9/08)

Financial market
disarray – Lehman
bankruptcy; AIG
backstopped
(9/08)

NBER dates June
2009 as official
recession end
(9/10)

Foreclosure procedures
questioned, halted and
federally mandated to
be improved at several
major banks/mortgage
servicers (10/10)

TARP funds of largest
banks repaid at a
profit to taxpayers:
JPMorgan (6/09);
Bank of America,
Wells Fargo, Citi
(12/09)

–700

Fallout through 2011
• FDIC’s “problem list” reaches a peak asset total of $431 billion (3/10) and peak
number of 888 banks (3/11).
• Roughly 400 smaller banks still owe nearly $2 billion in TARP funds (10/11).
• Only two of the 249 banks that failed in 2010 and 2011 held more than
$5 billion in assets (12/11).

Banking behemoth consolidation – Wells Fargo
acquires Wachovia; PNC acquires National City;
Goldman Sachs and Morgan Stanley become
bank holding companies (10/08)

Roughly 800,000 jobs lost per month
–900

2007
Mar

Jun

2008
Sep

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Dec

Mar

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Jun

2009
Sep

Dec

Mar

Jun

2010
Sep

Dec

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Mar

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Jun

Sep

Dec

The term TBTF disguised the fact that commercial banks holding roughly one-third of the assets in the banking system did
essentially fail, surviving only with extraordinary government
assistance.

Box 1
Degrees of Failure: Bankruptcies, Buyouts and Bailouts

F

or capitalist economies to thrive, weak companies must
go out of business. The reasons for failure vary from
outdated products, excess industry capacity, mismanagement and simple bad luck. The demise of existing firms
helps the economy by freeing up resources for new enterprises,
leaving healthier survivors in place. Joseph Schumpeter coined
the term “creative destruction” to describe this failure and
renewal process—a major driver of progress in a free-enterprise
economy. Schumpeter and his disciples view this process as
beneficial despite the accompanying loss of jobs, asset values
and equity.
The U.S. economy offers a range of options for this process of failure and rebirth:

agement, the corporate balance sheet and risk appetite. As
the company restructures, the government, often very slowly,
weans the company off life support.
Banks are special
The FDIC handles most bank failures through a resolution
similar to a private-sector buyout. The FDIC is funded primarily
by fees garnered from the banking industry. The failed institution’s shareholders, employees, management and unsecured
creditors still generally suffer significant losses, while insured
depositors are protected.
In the wake of the financial crisis, Dodd–Frank added a
new option: the Orderly Liquidation Authority (OLA). In theory,
OLA will follow the spirit of a Chapter 7 bankruptcy—liquidation of the failed firm’s assets—but in an “orderly” manner.
“Orderly” may involve some FDIC/government financing to
maximize firm value prior to the sale, thus blending some of
the degrees of failure already discussed.
Buyouts, bankruptcies and FDIC resolutions have a long
history of providing a reasonably predictable process that
imposes no costs to taxpayers. Bankruptcies and buyouts support creative destruction using private sector funding. By contrast, bailouts and OLA are specifically aimed at dealing with
too-big-to-fail institutions and are likely to involve some form of
taxpayer assistance since this degree of failure comes after
private sector solutions are deemed unavailable. Bailouts
provide delayed support of the creative destruction process,
using sometimes politically influenced taxpayer funds instead
of the free-enterprise route of reduction, rebirth and reallocation.
In essence, dealing with TBTF financial institutions necessitates quasi-nationalization of a private company, a process
antithetical to a capitalist system.

Bankruptcies
Enterprises beyond saving wind up in Chapter 7 bankruptcy, with operations ended and assets sold off. Firms with
a viable business but too much debt or other contractual
obligations usually file for Chapter 11 bankruptcy, continuing
to operate under court protection from creditors. Both forms
of bankruptcy result in a hit to stakeholders: shareholders,
employees, top managers and creditors are wiped out or
allowed to survive at a significant haircut. Bankruptcy means
liquidation or reduction; whether the bankrupt firm dies completely or scales down and survives with the same or similar
name, the end game is reallocation of resources.
Buyouts
A company facing potential bankruptcy may instead
be sold. The acquisition usually produces similar stakeholder
reduction results as a Chapter 11 bankruptcy, but without the
obliteration of equity ownership and creditor fallout.
Bailouts
The government steps in to prevent bankruptcy by providing
loans or new capital. The government becomes the most
senior secured creditor and begins downsizing losses, man-

Federal Reserve Bank of Dallas

But make no mistake about it: A bailout is a failure, just
with a different label.

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As housing markets deteriorated, policymakers became alarmed, seeing the number of big, globally interconnected banks
among the wounded. The loss of even
one of them, they feared, would create a
domino effect that would lead to a collapse of the payment system and severely
damage an economy already battered by
the housing bust.
Capital markets did in fact seize up
when Lehman Brothers, the fourth-largest
investment bank, declared bankruptcy in
September 2008. To prevent a complete
collapse of the financial system and to
unfreeze the flow of finance, the expedient fix was hundreds of billions of dollars
in federal government loans to keep these
institutions and the financial system afloat.
In short, the situation in 2008
removed any doubt that several of the
largest U.S. banks were too big to fail.4 At
that time, no agency compiled, let alone
published, a list of TBTF institutions. Nor
did any bank advertise itself to be TBTF.
In fact, TBTF did not exist explicitly, in
law or policy—and the term itself disguised the fact that commercial banks
holding roughly one-third of the assets
in the banking system did essentially fail,

surviving only with extraordinary government assistance (Exhibit 4).5 Most of the

failed outright between 2008 and 2011
numbered more than 400—the most since
the 1980s.
The housing bust and recession
disabled the financial system, stranding
many institutions on the roadway, creating
unprecedented traffic jams. Struggling

largest financial institutions did not fail in
the strictest sense. However, bankruptcies,
buyouts and bailouts facilitated by the
government nonetheless constitute failure
(Box 1). The U.S. financial institutions that

Exhibit 4
Total Assets of Failed and Assisted Institutions Reached
Extraordinary Levels

Total assets (billions of dollars)
400

300

372

1,917

2,000

$542
failed

’08–’09
$3.77 trillion
total failed/assisted

$3,223 assisted

1,306
1,000
170

200
0

’08
’09
Assisted institutions

Failed institutions

100

0
’70

’74

’78

’82

’86

’90

’94

SOURCE: Federal Deposit Insurance Corp.

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’98

’02

’06

’10

Psychological side effects of TBTF can’t be measured,
but they’re too important to ignore because they affect
economic behavior.

Exhibit 5

banks could not lend, slowing economic
activity. Massive layoffs followed, pinching
household and business spending, which
depressed stock prices and home values,
further reducing lending. These troubles
brought more layoffs, further reducing spending. Overall economic activity
bogged down.
The chain reaction that started in December 2007 became the longest recession
in the post-World War II era, lasting a total
of 18 months to June 2009. Real output
from peak to trough dropped 5.1 percent.
Job losses reached nearly 9 million. Unemployment peaked at 10 percent in October
2009.
The economy began seeing a slight
easing of congestion in mid-2009. With the
roadway beginning to clear of obstacles,
households and businesses sensed an opportunity to speed up. New jobs, higher
spending, rising asset prices and increased
lending all reinforce each other, building
up strength as the economy proceeds on a
growth path (Exhibit 5).

Positive Feedback

Real
income
grows

ssing Expa
greod begets goonsio
o
r Go
d

n

P

Employment
increases

Spending
increases

Profits
increase
Vehicle, home and
durable good
sales increase

Real
economy
expands

Credit
expands

Monetary Policy Engine
In an internal combustion engine,
small explosions in the cylinders’ combus-

Equipment,
software
and other business
investments increase

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tion chambers propel a vehicle; likewise,
the monetary policy engine operates
through cylinders that transmit the impact
of Fed actions to decisions made by businesses, lenders, borrowers and consumers
(Exhibit 6).6
When it wants to get the economy
moving faster, the Fed reduces its policy
interest rate—the federal funds rate, what
banks charge one another for overnight
loans. Banks usually respond by making more credit available at lower rates,
adding a spark to the bank loan cylinder
that drives borrowing by consumers and
companies. Subsequent buying and hiring
boost the economy.
Interest rates in money and capital markets generally fall along with the
federal funds rate. The reduced cost of
financing taking place in the securities
market cylinder enables many large businesses to finance expansion through sales
of stock, bonds and other instruments.
Increased activity occurs in the asset prices
and wealth cylinder stemming from the
propensity of falling interest rates to push
up the value of assets—bonds, equities,
homes and other real estate. Rising asset
values bolster businesses’ balance sheets

and consumers’ wealth, leading to greater
capacity to borrow and spend.

While reducing the interest burden for
borrowers, monetary policy in recent years
has had a punishing impact on savers,
Declining interest rates stimulate activity in the exchange rate cylinder, making particularly those dependent on shrinking
interest payments.
investing in U.S. assets less attractive relaIn the United States, economic
tive to other countries, putting downward
growth resumed in mid-2009—but it has
pressure on the dollar. The exchange rate
been tenuous and fragile through its first
adjustments make U.S. exports cheaper,
two-plus years. Annual growth has averstimulating employment and economic
activity in export industries. However, what aged about 2.5 percent, one of the weakest
rebounds of any post-WWII recovery. Stock
other countries do is important; if they
also lower interest rates, then the effect on prices quickly bounced back from their
exchange rates and exports will be muted. recessionary lows but seem suspended
in trendless volatility. Home prices have
From the first moments of the
languished.
financial crisis, the Fed has worked
At the same time, job gains have been
diligently—often quite imaginatively—to
repair damage to the banking and financial disappointing, averaging 120,000 a month
sectors, fight the recession, clear away
from January 2010 to December 2011,
impediments and jump-start the economy. less than half what they were in the midThe Fed has kept the federal funds
to late 1990s when the labor force was
rate close to zero since December 2008. To considerably smaller. Through 2011, only a
deal with the zero lower bound on the fed- third of the jobs lost in the recession have
eral funds rate, the Fed has injected billions been regained.
of dollars into the economy by purchasing
long-maturity assets on a massive scale,
What’s Different Now?
creating an unprecedented bulge in its
The sluggish recovery has confounded
balance sheet. That has helped push down monetary policy. Much more modest Fed
borrowing costs at all maturities to their
actions have produced much stronger
lowest levels in more than a half century.
results in the past. So, what’s different now?

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13

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A vehicle’s engine with one cylinder misfiring may get you
where you want to go; it just takes longer. The same goes for
the machinery of monetary policy, largely because of the
interdependence of all the moving parts.

Part of the answer lies in excesses that
haven’t been wrung out of the economy—
falling housing prices have been a lingering
drag. Jump-starting the housing market
would surely spur growth, but TBTF banks
remain at the epicenter of the foreclosure
mess and the backlog of toxic assets standing in the way of a housing revival. Mortgage credit standards remain relatively
tight.7

Exhibit 6
The Four Cylinders of the Monetary Policy Engine

Asset prices
and
wealth

Bank loan
Securities
market

Exchange
rate

Loan demand lags because of uncertainty about the economic outlook and
diminished faith in American capitalism.
Even though banks have begun easing
lending standards, potential borrowers believe the tight credit standards of 2008–10
remain in place.
Another part of the answer centers
on the monetary policy engine. It still isn’t
hitting on all cylinders, impairing the Fed’s
ability to stimulate the real economy’s
growth of output and employment. As a
result, historically low federal funds rates
haven’t delivered a large expansion of overall
credit. With bank lending weak, financial
markets couldn’t play their usual role in
recovery—revving up lending by nonbanks
to the household and business sectors.
A vehicle’s engine with one cylinder

Crankshaft

Bank capital lubricant
Connected to
economy:
households,
businesses
and governments

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misfiring may get you where you want to
go; it just takes longer. The same goes for
the machinery of monetary policy, largely
because of the interdependence of all the
moving parts. When one is malfunctioning, it degrades the rest. A scarcity of bank
credit, for example, inhibits firms’ capacity
to increase output for exports, undermining
the power within the exchange rate cylinder.
Similarly, the contributions to recovery
from securities markets and asset prices
and wealth have been weaker than expected. A prime reason is that burned investors
demand higher-than-normal compensation
for investing in private-sector projects. They
remain uncertain about whether the financial system has been fixed and whether
an economic recovery is sustainable. They
worry about additional financial shocks—
such as the euro zone crisis.

Sludge on the Crankshaft
A fine-tuned financial system requires
well-capitalized banks, with the resources
to cover losses from bad loans and investments. In essence, bank capital is a key
lubricant in the economic engine (see
Exhibit 6). Insufficient capital creates a
grinding friction that weakens the entire

financial system. Bank capital is an issue of
regulatory policy, not monetary policy. But

downside because most Americans came
away from the financial crisis believing that

monetary policy cannot be effective when
a major portion of the banking system is
undercapitalized.
The machinery of monetary policy
hasn’t worked well in the current recovery.
The primary reason: TBTF financial institutions. Many of the biggest banks have sputtered, their balance sheets still clogged with
toxic assets accumulated in the boom years.
In contrast, the nation’s smaller banks
are in somewhat better shape by some measures. Before the financial crisis, most didn’t
make big bets on mortgage-backed securities, derivatives and other highly risky assets
whose value imploded. Those that did were
closed by the Federal Deposit Insurance
Corp. (FDIC), a government agency.
Coming out of the crisis, the surviving
small banks had healthier balance sheets.
However, smaller banks comprise only onesixth of the banking system’s capacity and
can’t provide the financial clout needed for
a strong economic rebound.
The rationale for providing public
funds to TBTF banks was preserving the
financial system and staving off an even
worse recession. The episode had its

economic policy favors the big and wellconnected. They saw a topsy-turvy world
that rewarded many of the largest financial
institutions, banks and nonbanks alike, that
lost risky bets and drove the economy into
a ditch.8
These events left a residue of distrust
for the government, the banking system,
the Fed and capitalism itself (Box 2). These
psychological side effects of TBTF can’t be
measured, but they’re too important to
ignore because they affect economic behavior. People disillusioned with capitalism
aren’t as eager to engage in productive activities. They’re likely to approach economic
decisions with suspicion and cynicism,
shying away from the risk taking that drives
entrepreneurial capitalism. The ebbing of
faith has added friction to an economy trying to regain cruising speed.

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15

Shifting into Gear
Looking back at the financial crisis, recession and the tepid recovery that followed
points to two challenges facing the U.S.
economy in 2012 and beyond. The short
term demands a focus on repairing the

Federal Reserve Bank of Dallas

The verdict on Dodd–Frank will depend on what the final rules
look like. So far, the new law hasn’t helped revive the economy
and may have inadvertently undermined growth.

Box 2
TBTF: A Perversion of Capitalism

A

n unfortunate side effect of the government’s massive aid to TBTF
banks has been an erosion of faith in American capitalism. Ordinary
workers and consumers who might usually thank capitalism for their
higher living standards have seen a perverse side of the system, where
they see that normal rules of markets don’t apply to the rich, powerful and
well-connected.
Here are some ways TBTF has violated basic tenets of a capitalist system:
Capitalism requires the freedom to succeed and the freedom to fail.
Hard work and good decisions should be rewarded. Perhaps more important, bad decisions should lead to failure—openly and publicly. Economist Allan Meltzer put it this way: “Capitalism without failure is like religion
without sin.”
Capitalism requires government to enforce the rule of law. This requires
maintaining a level playing field. The privatization of profits and socialization of losses is completely unacceptable. TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and
powerful.
Capitalism requires businesses and individuals be held accountable
for the consequences of their actions. Accountability is a key ingredient
for maintaining public faith in the economic system. The perception—and
the reality—is that virtually nobody has been punished or held accountable for their roles in the financial crisis.
The idea that some institutions are TBTF inexorably erodes the foundations of our market-based system of capitalism.

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2011 Annual Report

financial system’s machinery, so the impacts
of monetary policy can be transmitted to
the economy quickly and with greater force.
To secure the long term, the country must
find a way to ensure that taxpayers won’t be
on the hook for another massive bailout.
Both challenges require dealing with
the threat posed by TBTF financial institutions; otherwise, it will be difficult to restore
confidence in the financial system and the
capitalist economy that depends on it.
The government’s principal response to
the financial crisis has been the Dodd–Frank
Wall Street Reform and Consumer Protection Act (Dodd–Frank), signed into law on
July 21, 2010. It’s a sprawling, complex piece
of legislation, addressing issues as diverse as
banks’ debit card fees and systemic risk to
the financial system. Since Dodd–Frank became law, at least a dozen agencies, including the Fed, have been working to translate
its provisions into regulations to govern the
financial system. They’re unlikely to finish
until 2013 at the earliest.
The verdict on Dodd–Frank will
depend on what the final rules look like.
So far, the new law hasn’t helped revive the
economy and may have inadvertently undermined growth by adding to uncertainty

about the future.
A prolonged legislative process preceded the protracted implementation period,
with bureaucratic procedure trumping
decisiveness. Neither banks nor financial
markets know what the new rules will be,
and the lack of clarity is delaying repair of
the bank-lending and financial market parts
of the monetary policy engine.
The law’s sheer length, breadth and
complexity create an obstacle to transparency, which may deepen Main Street’s
distrust of Washington and Wall Street,
especially as big institutions use their lawyers and lobbyists to protect their turf. At
the same time, small banks worry about a
massive increase in compliance burdens.
Policymakers can make their most immediate impact by requiring banks to hold
additional capital, providing added protection against bad loans and investments. In
the years leading up to the financial crisis,
TBTF banks squeezed equity to a minimum.
They ran into trouble because they used
piles of debt to expand risky investments—
in the end finding that excessive leverage is
lethal.
The new regulations should establish
basic capital levels for all financial institu-

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17

tions, tacking on additional requirements
for the big banks that pose systemic risk,
hold the riskiest assets and venture into the
more exotic realms of the financial landscape.9 Mandating larger capital cushions
tied to size, complexity and business lines
will give TBTF institutions more “skin in
the game” and restore some badly needed
market discipline. Overall, the revised regulatory scheme should provide incentives to
cut risk. Some banks may even rethink their
mania for growing bigger.
Higher capital requirements across
the board could burden smaller banks and
probably further crimp lending. These institutions didn’t ignite the financial crisis. They
didn’t get much of a helping hand from
Uncle Sam. They tend to stick to traditional
banking practices. They shouldn’t face the
same regulatory burdens as the big banks
that follow risky business models.
TBTF banks’ sheer size and their
presumed guarantee of government help
in time of crisis have provided a significant
edge—perhaps a percentage point or
more—in the cost of raising funds.10 Making these institutions hold added capital
will level the playing field for all banks,
large and small.

Federal Reserve Bank of Dallas

Higher capital requirements across the board could burden smaller banks and probably further crimp lending.
These institutions shouldn’t face the same regulatory burdens as the big banks that follow risky business models.

Facing higher capital requirements,
the biggest banks will need to raise additional equity through stock offerings or increased retained earnings through reduced
dividends. Attracting new investment will
be comparatively less burdensome for the
healthiest institutions, difficult for many
and daunting for the weaker banks.
Dodd–Frank leaves the details for
rebuilding capital to several supervisory
agencies. The specifics are still being worked
out; it appears banks will have until 2016 or
2017 to meet the higher thresholds.
Given the urgent need for restoring
the vitality of the banking industry, this may
seem a long wait. However, capital rebuilding will likely take place faster as the stronger
banks recognize the advantages of being
first movers. Recently, many of the largest
banks have made efforts to raise capital and
have met or surpassed supervisory expectations for capital adequacy under stress
tests.11
Banks that quickly clean up their
balance sheets will have a better chance
of raising new funds—so they can then be
in shape to attract even more new capital.
Past evidence shows that financial markets
favor institutions that offer the best pros-

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2011 Annual Report

pects for returns with acceptable risk.12
Laggards will be worse off, finding it
even more difficult to attract new investors. Ultimately, these institutions will
further weaken and may need to be broken
up, their viable parts sold off to competitors. With the industry already too concentrated, it’s important to redistribute these
banking assets in a way that enhances
overall competition.
Ensuring that banks have adequate
capital is essential to effective monetary
policy. It comes back to the bank capital
linkage, which recognizes that banks must
have healthy capital ratios to expand
lending and absorb losses that normally
occur. Repairing the damaged mechanism
through which monetary policy impacts
the economy will be the key to accelerating
positive feedbacks.
To some extent, the Fed’s zero interest
rate policy, adopted in December 2008 at
the height of the financial crisis, assisted
the banking industry’s capital rebuilding
process. It reduced banks’ costs of funds
and enhanced profitability. But short-term
interest rates cannot cross the zero lower
bound, limiting any additional impact from
this capital-building mechanism. It could

be argued that zero interest rates are taxing
savers to pay for the recapitalization of the
TBTF banks whose dire problems brought
about the calamity that created the original need for the zero interest rate policy.
Unfortunately, the sluggish recovery is
a cost of the long delay in establishing the
new standards for bank capital. Given the
urgent need to restore economic growth
and a healthy job market, the guiding principles for bank capital regulation should
be: codify and clarify, quickly. There is no
statutory mandate to write hundreds of
pages of regulations and hundreds more
pages of commentary and interpretation.
Millions of jobs hang in the balance.

A Potential Roadblock
Dodd–Frank says explicitly that
American taxpayers won’t again ride to the
rescue of troubled financial institutions. It
proposes to minimize the possibility of an
Armageddon by revamping the regulatory
architecture.
As part of its strategy to end TBTF,
Dodd–Frank expanded the powers of the
Fed, FDIC and most other existing regulators. New watchdogs will be put on alert.
A 10-member Financial Stability Oversight

Council (FSOC), aided by a new Office
of Financial Research, has been charged

dog and funded by fees charged to the
biggest financial institutions.

with monitoring systemic risk. It will try to
identify and resolve problems at big banks
and other financial institutions before they
threaten the financial system. In an effort
to increase transparency, much of the new
information will be made public. Opaque
business practices thwart market discipline.
Can Dodd–Frank do what was
unthinkable back in 2008—identify and
liquidate systemically important financial
institutions in an orderly manner that
minimizes risk to the financial system and
economy?
The current remedy for insolvent
institutions works well for smaller banks,
protecting customers’ money while
the FDIC arranges sales or mergers that
transfer assets and deposits to healthy
competitors. During the financial crisis,
however, the FDIC didn’t have the staff,
financial resources and time to wind down
the activities of even one truly mammoth
bank. Thus, many TBTF institutions stayed
in business through government support.13
Dodd–Frank envisions new procedures for troubled big banks and financial
institutions, directed by the FSOC watch-

The goal is an alternative to the TBTF
rescues of the past three decades. In practice, these rescues have penalized equity
holders while protecting bond holders and,
to a lesser extent, bank managers. Disciplining the management of big banks, just as
happens at smaller banks, would reassure a
public angry with those whose reckless decisions necessitated government assistance.
Will the new resolution procedures
be adequate in a major financial crisis?
Big banks often follow parallel business
strategies and hold similar assets. In hard
times, odds are that several big financial
institutions will get into trouble at the
same time.14 Liquid assets are a lot less
liquid if these institutions try to sell them
at the same time. A nightmare scenario of
several big banks requiring attention might
still overwhelm even the most far-reaching
regulatory scheme. In all likelihood, TBTF
could again become TMTF—too many to
fail, as happened in 2008.
A second important issue is credibility. Going into the financial crisis, markets
assumed there was government backing
for Fannie Mae and Freddie Mac bonds

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19

Federal Reserve Bank of Dallas

A financial system composed of more banks—numerous
enough to ensure competition but none of them big enough
to put the overall economy in jeopardy—will give the United
States a better chance of navigating through future financial
potholes, restoring our nation’s faith in market capitalism.

despite a lack of explicit guarantees. When
push came to shove, Washington rode to
the rescue. Similarly, no specific mandate
existed for the extraordinary governmental
assistance provided to Bear Stearns, AIG,
Citigroup and Bank of America in the midst
of the financial crisis.15 Lehman Brothers
didn’t get government help, but many of
the big institutions exposed to Lehman
did.16
Words on paper only go so far. What
matters more is whether bankers and their
creditors actually believe Dodd–Frank puts
the government out of the financial bailout
business. If so, both groups will practice
more prudent behavior.
Dodd–Frank has begun imposing
some market discipline and eroding the big
banks’ cost-of-funds advantage. Creditrating agencies have lowered the scores
for some larger banks, recognizing that the
law reduces government bailout protections that existed just a few years ago and
that Washington’s fiscal problems limit its
ability to help beleaguered financial institutions in a financial emergency.
While decrying TBTF, Dodd–Frank
lays out conditions for sidestepping the
law’s proscriptions on aiding financial insti-

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2011 Annual Report

tutions. In the future, the ultimate decision
won’t rest with the Fed but with the Treasury secretary and, therefore, the president.
The shift puts an increasingly political
cast on whether to rescue a systemically
important financial institution. (It may be
hard for many Americans to imagine political leaders sticking to their anti-TBTF guns,
especially if they face a too-many-to-fail
situation again.)
If the new law lacks credibility, the
risky behaviors of the past will likely recur,
and the problems of excessive risk and
debt could lead to another financial crisis.
Government authorities would then face
the same edge-of-the-precipice choice they
did in 2008—aid the troubled banking
behemoths to buoy the financial system or
risk grave consequences for the economy.
The pretense of toughness on TBTF
sounds the right note for the aftermath of
the financial crisis. But it doesn’t give the
watchdog FSOC and the Treasury secretary
the foresight and the backbone to end
TBTF by closing and liquidating a large
financial institution in a manner consistent
with Chapter 7 of the U.S. Bankruptcy Code
(see Box 1). The credibility of Dodd–Frank’s
disavowal of TBTF will remain in question

until a big financial institution actually fails
and the wreckage is quickly removed so the
economy doesn’t slow to a halt. Nothing
would do more to change the risky behavior of the industry and its creditors.
For all its bluster, Dodd–Frank leaves
TBTF entrenched. The overall strategy
for dealing with problems in the financial
industry involves counting on regulators to
reduce and manage the risk. But huge institutions still dominate the industry—just as
they did in 2008. In fact, the financial crisis
increased concentration because some
TBTF institutions acquired the assets of
other troubled TBTF institutions.
The TBTF survivors of the financial
crisis look a lot like they did in 2008. They
maintain corporate cultures based on the
short-term incentives of fees and bonuses
derived from increased oligopoly power.
They remain difficult to control because
they have the lawyers and the money to resist the pressures of federal regulation. Just
as important, their significant presence in
dozens of states confers enormous political
clout in their quest to refocus banking statutes and regulatory enforcement to their
advantage.
The Dallas Fed has advocated the ulti-

mate solution for TBTF—breaking up the
nation’s biggest banks into smaller units.17
It won’t be easy for several reasons. First,
the prospect raises a range of thorny issues
about how to go about slimming down the
big banks. Second, the level of concentration considered safe will be difficult to
determine. Is it rolling things back to 1990?
Or 1970? Third, the political economy of
TBTF suggests that the big financial institutions will dig in to contest any breakups.
Taking apart the big banks isn’t costless. But it is the least costly alternative, and
it trumps the status quo.18
A financial system composed of
more banks, numerous enough to ensure
competition in funding businesses and
households but none of them big enough
to put the overall economy in jeopardy,
will give the United States a better chance
of navigating through future financial
potholes and precipices. As this more
level playing field emerges, it will begin to
restore our nation’s faith in the system of
market capitalism.

Taking the Right Route
Periodic stresses that roil the financial
system can’t be wished away or legislated

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21

out of existence. They arise from human
weaknesses—the complacency that comes
from sustained good times, the greed and
irresponsibility that run riot without market discipline, the exuberance that overrules common sense, the complicity that
results from going along with the crowd.
We should be vigilant for these failings, but
we’re unlikely to change them. They’re a
natural part of our human DNA.
By contrast, concentration in the
financial sector is anything but natural.
Banks have grown larger in recent years because of artificial advantages, particularly
the widespread belief that government will
rescue the creditors of the biggest financial
institutions. Human weakness will cause
occasional market disruptions. Big banks
backed by government turn these manageable episodes into catastrophes.
Greater stability in the financial sector
begins when TBTF ends and the assumption of government rescue is driven from
the marketplace. Dodd–Frank hopes to
accomplish this by foreswearing TBTF,
tightening supervision and compiling more
information on institutions whose failure
could upend the economy.
These well-intentioned initiatives may

Federal Reserve Bank of Dallas

The road to prosperity requires recapitalizing the financial system as quickly as possible. Achieving an economy relatively
free from financial crises requires us to have the fortitude to
break up the giant banks.

be laudable, but the new law leaves the
big banks largely intact. TBTF institutions
remain a potential danger to the financial
system. We can’t be sure that some future
government won’t choose the expediency
of bailouts over the risk of severe recession
or worse. The only viable solution to TBTF
lies in reducing concentration in the banking system, thus increasing competition
and transparency.
The road to prosperity requires recapitalizing the financial system as quickly
as possible. The safer the individual banks,
the safer the financial system. The ultimate
destination—an economy relatively free
from financial crises—won’t be reached
until we have the fortitude to break up the
giant banks.
Harvey Rosenblum is the Dallas Fed’s
executive vice president and director of
research. Special mention and thanks go
to Richard Alm for his journalistic assistance, to David Luttrell for research and
documentation, and to Samantha Coplen
and Darcy Melton for their artistry in the
exhibits.

Notes
“Taming the Credit Cycle by Limiting High-Risk
Lending,” by Jeffery W. Gunther, Federal Reserve
Bank of Dallas Economic Letter, vol. 4, no. 4, 2009.

1

See speech by U.S. Attorney General Eric
Holder, Columbia University Law School, New
York City, Feb. 23, 2012, in which he noted that
“much of the conduct that led to the financial
crisis was unethical and irresponsible … but this
behavior—while morally reprehensible—may
not necessarily have been criminal.” www.
justice.gov/iso/opa/ag/speeches/2012/agspeech-120223.html

2

A structured investment vehicle (SIV) is an “offbalance-sheet” legal entity that issues securities
collateralized by loans or other receivables from
a separate but related entity while investing in
assets of longer maturity. Several of the largest
banks used SIVs to issue commercial paper to
fund investments in high-yielding securitized
assets. When these risky assets began to default,
the banks reluctantly took them back onto their
balance sheets and suffered large write-downs.

3

In conjunction with the 1984 rescue of Continental Bank, the Comptroller of the Currency,
the supervisor of nationally chartered banks,
acknowledged the TBTF status of the largest
banks. See “U.S. Won’t Let 11 Biggest Banks in Nation Fail,” by Tim Carrington, Wall Street Journal,
Sept. 20, 1984.

the amount of capital drained from the banking
system due to failures during the crisis pales in
comparison with the $3.2 trillion in assets associated with institutions receiving extraordinary
assistance from the FDIC during this period, most
of it involving just two entities, Citigroup and
Bank of America.
“Regulatory and Monetary Policies Meet ‘Too
Big to Fail,’” by Harvey Rosenblum, Jessica K.
Renier and Richard Alm, Federal Reserve Bank of
Dallas Economic Letter, vol. 5, no. 3, 2010.

6

According to the July 2011 Federal Reserve
Senior Loan Officer Opinion Survey, a majority
of large banks have eased standards for consumer loans and for commercial and industrial
loans. However, credit standards on residential
and commercial real estate lending remain
tight over the period since 2005.

7

Taxpayers’ money wasn’t “given” to the banks.
It was loaned, and most loans have been
repaid with interest. Nevertheless, the perception remains that bailout dollars were gifts. And
perception drives public sentiment.

8

4

In 2008 and 2009, the Federal Deposit Insurance Corp. (FDIC) facilitated the failure of 165
institutions with $542 billion in assets. The largest
bank failure in history occurred when Washington Mutual shuttered its doors in late September
2008, its $307 billion in assets accounting for
the lion’s share of the $372 billion total of failed
institutions’ assets that year. Although staggering,

5

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2011 Annual Report

At this time (March 2012), it appears that bank
capital regulations under Dodd–Frank will follow
the Basel III framework, with capital surcharges
of at least 1 percentage point imposed on
global systemically important financial institutions (G-SIFIs). In addition, a more realistic
definition of capital is likely to be put in place to
avoid a repeat of the situation in 2008–09, when
two of the largest banks were never rated less
than “adequately capitalized” at the height of
the crisis, while at the same time they together
received hundreds of billions in capital infusions
and loan guarantees and never made it onto
the FDIC’s Problem Bank List.

9

10
See “How Much Did Banks Pay to Become
Too-Big-to-Fail and to Become Systemically
Important?,” by Elijah Brewer III and Julapa
Jagtiani, Federal Reserve Bank of Philadelphia,
Working Paper no. 11-37, 2011, and the literature
cited therein.

11
The Federal Reserve’s Comprehensive Capital
Analysis and Review (CCAR) evaluates the capital planning processes and capital adequacy
of the largest bank holding companies. This exercise includes a supervisory stress test to evaluate
whether firms would have sufficient capital in
times of severe economic and financial stress.
In the CCAR results released on March 13, 2012,
15 of the 19 bank holding companies were
estimated to maintain capital ratios above
regulatory minimum levels under the hypothetical stress scenario, even after considering the
proposed capital actions, such as dividend
increases or share buybacks. For more information, see www.federalreserve.gov/newsevents/
press/bcreg/20120313a.htm.

12
In the early 1990s, financial markets rewarded
banks for increasing their capital-to-asset ratios.
Banks that held more capital had higher returns
on equity (ROE) primarily because of reduced
interest rates paid for uninsured liabilities.
See “Banking in the 21st Century,” by Alan
Greenspan, remarks at the 27th Annual Conference on Bank Structure and Competition, Federal
Reserve Bank of Chicago, May 2, 1991, especially
pp. 9–10. In addition, banks were rewarded with
higher equity prices for dividend retention and
issuance of new stock, two methods of raising
capital that bankers generally claim will reduce
stock prices. See “Bank Capital Ratios, Asset
Growth and the Stock Market,” by Richard Cantor and Ronald Johnson, Federal Reserve Bank
of New York FRBNY Quarterly Review, Autumn
1992, pp. 10–24 (emphasis added).

13
For other large nonbank financial firms (for
example, Lehman Brothers, AIG and Bear
Stearns) and for bank holding companies, there
was no resolution authority at all. The choice
came down to buyouts, bankruptcies or bailouts
(see Box 1). With no private-sector buyers willing
to step up, and with bankruptcy generally a
long and uncertain process, government intervention in the form of bailouts became the least
disruptive alternative, at least in the short run.

14
The FDIC estimates that it could have
performed an orderly liquidation of Lehman, if
it had Dodd–Frank powers six months before
Lehman declared Chapter 11 bankruptcy in
September 2008, and would have paid creditors
97 percent of what they were owed. But this assumes that other giant financial institutions did
not require simultaneous and similar attention.

15
On March 24, 2008, the Federal Reserve Bank
of New York announced that it would provide
term financing to facilitate JPMorgan’s buyout
of Bear Stearns at $10/share, or $1.4 billion. On
Sept. 15, 2008, the world’s largest underwriter of
mortgage bonds, Lehman Brothers, filed for the
world’s largest bankruptcy with listed liabilities of
$613 billion. The following day, one of the world’s
largest insurance organizations and counterparties for credit default swaps, AIG, received
Federal Reserve support: an $85 billion secured
credit facility amid credit rating downgrades
and financial market panic. On Nov. 23, 2008,
the Treasury, Federal Reserve and the FDIC
entered into an agreement with Citigroup to
provide a package of guarantees, liquidity access and nonrecourse capital to protect against
losses on an asset pool of approximately $306
billion of loans and securities. On Jan. 16, 2009,
a similar government loan-loss agreement was
offered to Bank of America, backstopping an asset pool of $118 billion, a large majority of which
was assumed as a result of BofA’s acquisition of
broker-dealer Merrill Lynch.

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23

16
More than three years have passed since
the Lehman bankruptcy. A vigorous debate
persists regarding (1) whether the Fed could
have found a way to bail out Lehman and
(2) whether this might have avoided a global
financial and economic collapse. Using data
from late 2008 and early 2009 shown in Exhibit
3, the inescapable answer to both questions is:
It would not have mattered. Two days later, AIG
was essentially nationalized, and within a matter
of a few months, the already imbedded but unrecognized and undisclosed losses at Citigroup
and Bank of America necessitated a combined
Fed and FDIC assistance package that quasinationalized these institutions. The extent of
these losses was disavowed by managements
up until assistance packages were announced.

17
“Taming the Too-Big-to-Fails: Will Dodd–Frank
Be the Ticket or Is Lap-Band Surgery Required?,”
speech by Richard Fisher, president and chief
executive officer of the Federal Reserve Bank of
Dallas, Columbia University’s Politics and Business Club, New York City, Nov. 15, 2011; “Financial
Reform or Financial Dementia?,” by Richard
Fisher, Southwest Graduate School of Banking
53rd Annual Keynote Address, Dallas, June 3,
2010; “Paradise Lost: Addressing ‘Too Big to Fail,’”
speech by Richard Fisher, Cato Institute’s 27th
Annual Monetary Conference, Washington, D.C.,
Nov. 19, 2009.

18
Evidence of economies of scale (that is, reduced average costs associated with increased
size) in banking suggests that there are, at best,
limited cost reductions beyond the $100 billion
asset size threshold. Cost reductions beyond this
size cutoff may be more attributable to TBTF subsidies enjoyed by the largest banks, especially
after the government interventions and bailouts
of 2008 and 2009. See “Scale Economies Are a
Distraction,” by Robert DeYoung, Federal Reserve
Bank of Minneapolis The Region, September
2010, pp. 14–16, as well as Brewer and Jagtiani,
note 10. However, Dodd–Frank seeks to reduce
these TBTF subsidies.

Federal Reserve Bank of Dallas

Year in Review
Eleventh Federal Reserve District

T

he vibrant economy of the Eleventh
Federal Reserve District became
the focus of national attention in
2011 as the region grew significantly faster
than the nation. Employment increased by 2
percent—212,000 jobs—compared with 1.3
percent nationally. The district employs over
11 million workers.
Texas, which makes up the major part of
the Eleventh District, was the last state to enter the recent recession and one of the strongest coming out, moving from recovery to
expansion in 2011. A source of Texas economic
strength, oil and gas extraction recorded a 25
percent increase in the number of drilling rigs
in 2011, almost reaching its mid-2008 peak.
Texas exports grew at a faster pace than in
the rest of the U.S., and housing continued to
mend.
The district’s economy appears poised for
another year of moderate growth as leading
economic indicators increased at the end of
2011. Slower growth in exports and energy will
likely be offset by a gradual improvement in
construction and fewer cuts in state and local
government jobs.

Monetary Policy and Research
The Dallas Fed began providing to the
public a timely state-level gauge of service
sector activity with the introduction midyear
of the Texas Service Sector Outlook Survey
(TSSOS). The service sector drives the Texas
economy, and TSSOS fills a regional data
gap. Both TSSOS and the established Texas

Federal Reserve Bank of Dallas

24

2011 Annual Report

Manufacturing Outlook Survey (TMOS) are
routinely cited in the business media and have
proved to be reliable indicators of the Texas
economy.
The Bank conducts high-level research
that contributes to the understanding of our
dynamic economy. Research staff had 27 new
submissions and nine acceptances in refereed
journals. The Bank’s economists presented
research at 40 meetings, organized or chaired
sessions or served as discussants at 20 conferences, gave 31 academic seminars at universities, central banks or other research institutions and presented over 260 speeches to area,
district and national audiences.
The Globalization and Monetary Policy
Institute continued to expand its reach and
activities. The institute’s staff, fellows and
research associates circulated working papers
that were read extensively worldwide, and
several of those papers were accepted for
publication in leading international academic
journals, such as the Journal of International
Economics. The institute cosponsored a conference with the Swiss National Bank in Zurich
on the globalization of inflation and held its
inaugural public lecture, “Globalization and
Monetary Policy: From Virtue to Vice?,” delivered by Jürgen Stark, member of the executive
board of the European Central Bank.

Financial Services
The new Go Direct® Contact Center began operations in March 2011 to support the
All-Electronic Treasury Initiative. To accom-

One of the most diverse regions of the country, culturally, economically and geographically

modate expansion of Go Direct operations,
staff members were relocated to a new space
on the ground floor of the Dallas building that
was previously used for check processing. Staff
levels were increased to handle phone calls
generated by the Treasury’s announcement
and promotion of the initiative, designed to
move federal benefit recipients from paper to
electronic payments.
To reduce operating costs, the Bank
replaced the San Antonio office’s cash services
operation with a cash depot administered
by the Houston Branch. The Dallas Fed has
completed a multiyear upgrade to its highspeed currency processing machines, thereby
increasing processing capability to 100,000
notes per hour.

Banking Supervision and
Discount and Credit
The Bank continued its active participation in the implementation of the Dodd–
Frank Wall Street Reform and Consumer
Protection Act, signed into law in July 2010. In
addition to the 39 state member banks and
459 bank holding companies the Dallas Fed
supervises, the Bank on July 21, 2011, became
the federal supervisor for 23 savings-and-loan
holding companies (SLHCs) in the Eleventh
District, ranging in size from less than $150
million to more than $100 billion in assets.
Banking Supervision added staff to oversee
SLHCs and to prepare for implementing
enhanced supervision standards for the largest
financial services organizations as required by

gram advanced the concept of asset building
through events across Texas. Partnering with
RAISE Texas, Texas Rural Innovators and local
hosts, Bank staff brought together practitioners, service providers and policymakers in
Texas’ rural communities to explore innovative
ways to help families achieve financial security.
Office of Minority and Women The Bank also organized and hosted conferences on Hispanic migration, labor and social
Inclusion
trends to widen understanding of this dynamic
As mandated by the Dodd–Frank Act, the
population; social influences on health to
Bank established an Office of Minority and
understand how groups are collaborating
Women Inclusion (OMWI). The OMWI is
designed to ensure that minorities and women with leaders in community development and
health; and housing issues for people with disare fairly included in employment-related activities and that minority- and women-owned abilities to identify challenges, new initiatives
businesses have an increasing role as providers and financing opportunities.
The Dallas Fed held events across the
of goods and services. Further, the OMWI’s influence extends to efforts to support financial Eleventh District to provide an opportunity
literacy and economic education in the Bank’s for CEOs of financial institutions to meet with
the Bank’s top leaders and discuss regional ecoservice areas.
nomic issues and matters affecting banking. The
Bank reached more than 3,000 banks and credit
Public Outreach
The Bank remains committed to provid- unions at roundtables on economic topics in
ing high-quality informational and educational communities across the district and hosted four
webcasts on current economic issues.
programs that improve financial literacy and
The Bank’s Community Depository
help the public know and understand the
Institutions Advisory Council and San Antonio
structure and role of the Fed.
Regional Bank Council continued to provide
The Bank’s economic education programs reach several thousand educators each essential information about the changing
practices of financial institutions, in particular
year, and through them, tens of thousands of
community banks. In 2011, the Bank formed
students. The Economics Scholars Program,
presented in cooperation with Austin College, a Corporate Payments Council—whose
members represent large retail operations—so
brought together 150 participants from 44
it can stay in touch with the evolving payment
universities and colleges across 14 states.
services practices of the corporate community.
The Community Development proDodd–Frank.
To reduce the cost to and burden on
depository institutions, the Federal Reserve
System announced an initiative to simplify
administration of the framework under which
organizations calculate and maintain reserves.

2011 Annual Report

25

Federal Reserve Bank of Dallas

Senior Management

(Left to right) seated: Holcomb and Fisher; standing: Kolson, Gholson, McKee, Peschel, Hastings, Black, Hankins, Rosenblum, Sweatt and Gilmer.

Richard W. Fisher
President and CEO

Meredith N. Black
Senior Vice President

Helen E. Holcomb
First Vice President and COO

J. Tyrone Gholson
Senior Vice President and
OMWI Director

Robert D. Hankins
Executive Vice President
Harvey Rosenblum
Executive Vice President and
Director of Research

Millard E. Sweatt
Senior Vice President and
Secretary
Robert W. Gilmer
Vice President in Charge
El Paso Branch

Joanna O. Kolson
Senior Vice President

Blake Hastings
Vice President in Charge
San Antonio Branch

Kenneth V. McKee
Senior Vice President and
General Auditor

Federal Reserve Bank of Dallas

Daron D. Peschel
Vice President in Charge
Houston Branch

26

2011 Annual Report

Federal Reserve Bank of Dallas
Officers/Senior Professionals

Michael N. Turner
Assistant Vice President

Dallas

Hazel W. Adams
Credit Risk Systems Officer

Richard W. Fisher
President and CEO
Helen E. Holcomb
First Vice President and COO
Robert D. Hankins
Executive Vice President
Harvey Rosenblum
Executive Vice President and
Director of Research
Meredith N. Black
Senior Vice President
J. Tyrone Gholson
Senior Vice President and
OMWI Director
Joanna O. Kolson
Senior Vice President
Kenneth V. McKee
Senior Vice President and
General Auditor
Millard E. Sweatt
Senior Vice President and
Secretary
Earl Anderson
Vice President
Diane M. de St. Germain
Vice President
John V. Duca
Vice President and
Senior Policy Advisor
Robert G. Feil
Vice President and
Associate Secretary
Sherry Kidd Garvin
Vice President

Marion E. White
Assistant Vice President

William C. Morse Jr.
Vice President

Laurel M. Brewster
Public Affairs Officer

Alfreda B. Norman
Vice President
and Community Development Officer

Bobby E. Coberly Jr.
Examining Officer

Sharon A. Sweeney
Vice President,
Acting General Counsel
and Associate Secretary

Jeffrey L. Garrett
Financial Management Officer
D. Kay Gribbin
Administrative Officer

Robert L. Triplett III
Vice President

James R. Hoard
Public Affairs Officer

E. Ann Worthy
Vice President

Robert R. Moore
Research Officer

Mark A. Wynne
Vice President and
Director of the Globalization
and Monetary Policy Institute

Pia M. Orrenius
Research Officer

Mine Yücel
Vice President

Vincent G. Pacheco
Examining Officer

Tommy E. Alsbrooks
Assistant Vice President

Allen E. Qualman
Operations Officer

Glenda S. Balfantz
Assistant Vice President
and Assistant General Auditor

Kenneth J. Robinson
Research Officer

Stephan D. Booker
Assistant Vice President

Thomas F. Siems
Economic Outreach
Senior Professional

Claude H. Davis
Assistant Vice President

Jay Sudderth
Relationship Management Officer

Paul T. Elzner
Assistant Vice President

El Paso

Rob Jolley
Assistant Vice President

Robert W. Gilmer
Vice President in Charge

Richard J. Mase Jr.
Assistant Vice President

Javier R. Jimenez
Assistant Vice President

KaSandra Goulding
Vice President

Dana S. Merritt
Assistant Vice President
and OMWI Assistant Director

Houston

Jeffery W. Gunther
Vice President

Dean A. Pankonien
Assistant Vice President

Daron D. Peschel
Vice President in Charge

Kathy K. Johnsrud
Vice President

Rita Riley
Assistant Vice President

Donald N. Bowers II
Assistant Vice President

Evan F. Koenig
Vice President
and Senior Policy Advisor

Margaret C. Schieffer
Assistant Vice President

Randy L. Steinley
Assistant Vice President

William W. Shaffer Jr.
Assistant Vice President

Michelle D. Treviño
Administrative Officer

Harvey R. Mitchell III
Vice President

San Antonio
Blake Hastings
Vice President in Charge
D. Karen Diaz
Assistant Vice President
Eleventh District
Advisory Council 2011
Jerred G. Blanchard Jr.
(Chairman)
Principal, Ernst & Young LLP
Houston
Charles E. Amato
Chairman, SWBC
San Antonio
Crawford Brock
Owner, Stanley Korshak
Dallas
Henry Hernandez
CEO, Las Palmas Medical Center
El Paso, Texas
Renard U. Johnson
President and CEO, METI Inc.
El Paso, Texas
Frank Mihalopoulos
President, Corinth Properties
Dallas
John P. Nichols
Professor and Head
Department of Agricultural Economics
Texas A&M University
College Station, Texas
Deborah Rogers
Owner, Deborah’s Farmstead
Fort Worth
Gerald J. Rubin
Chairman, President and CEO
Helen of Troy Ltd.
El Paso, Texas
G.P. Singh
Owner, Gur Parsaad Properties Ltd.
San Antonio
Dale W. Tremblay
President and CEO
C.H. Guenther & Son Inc.
San Antonio
Debby A. Weber
Sole Proprietor
Weber Design Associates
Dallas
Federal Advisory
Council Member
Richard W. Evans Jr.
Chairman and CEO
Cullen/Frost Bankers Inc.
San Antonio
As of December 31, 2011

2011 Annual Report

27

Federal Reserve Bank of Dallas

Boards of Directors
Dallas

Herbert D. Kelleher
(Chairman)
Founder and Chairman Emeritus,
Southwest Airlines Co.

Myron E. Ullman III
(Deputy Chairman)
Executive Chairman,
J.C. Penney Co. Inc.

James B. Bexley
Professor of Finance,
Sam Houston State University

Pete Cook
CEO,
First National Bank
in Alamogordo

Elton Hyder
President,
The EMH Corp.

George F. Jones Jr.
CEO,
Texas Capital Bank

Margaret H. Jordan
President and CEO,
Dallas Medical Resource

Renu Khator
Chancellor and President,
University of Houston

Joe Kim King
CEO,
Brady National Bank

Federal Reserve Bank of Dallas

28

2011 Annual Report

El Paso

D. Kirk Edwards
(Chairman)
President,
MacLondon Royalty Co.

Cindy J. Ramos-Davidson
(Chairman Pro Tem)
President and CEO,
El Paso Hispanic
Chamber of Commerce

Martha I. Dickason
President,
dmDickason Personnel Services

Robert E. McKnight Jr.
Owner,
McKnight Ranch Co.

Robert Nachtmann
Dean,
College of Business Administration,
University of Texas at El Paso

Larry L. Patton
President and CEO,
Bank of the West

2011 Annual Report

29

Federal Reserve Bank of Dallas

Laura M. Conniff
Qualifying Broker,
Mathers Realty Inc.

Houston

Paul W. Hobby
(Chairman)
Chairman and Managing Partner,
Genesis Park LP

Jorge A. Bermudez
(Chairman Pro Tem)
President and CEO,
Byebrook Group LLC

Greg L. Armstrong
Chairman and CEO,
Plains All American Pipeline LP

Kirk S. Hachigian
Chairman and CEO,
Cooper Industries Ltd.

Paul B. Murphy Jr.
President and CEO,
Cadence Bank

Gerald B. Smith
Cofounder, Chairman and CEO
Smith, Graham and Co.
Investment Advisors LP

Ann B. Stern
Executive Vice President,
Texas Children’s Hospital

Federal Reserve Bank of Dallas

30

2011 Annual Report

San Antonio

Steven R. Vandegrift
(Chairman)
Founder and President,
SRV Holdings

Catherine M. Burzik
(Chairman Pro Tem)
President and CEO,
Kinetic Concepts Inc.

Thomas E. Dobson
Chairman and CEO,
Whataburger Restaurants LP

Ygnacio D. Garza
Partner,
Long Chilton LLP

Josue Robles Jr.
President and CEO,
USAA

Guillermo F. Trevino
President,
Southern Distributing Co.

2011 Annual Report

31

Federal Reserve Bank of Dallas

Curtis V. Anastasio
President and CEO,
NuStar Energy LP

Financial/Audit

Examinations of the
Reserve Bank
The Reserve Banks and the consolidated
limited liability company (LLC) entities are
subject to several levels of audit and review.
The combined financial statements of the
Reserve Banks as well as the annual financial
statements of each of the 12 Banks and the
consolidated LLC entities are audited annually
by an independent auditing firm retained
by the Board of Governors. In addition, the
Reserve Banks, including the consolidated LLC
entities, are subject to oversight by the Board
of Governors, which performs its own reviews.
The Reserve Banks use the framework
established by the Committee of Sponsoring
Organizations of the Treadway Commission
(COSO) to assess their internal controls over
financial reporting, including the safeguarding
of assets. Within this framework, the management of each Reserve Bank annually provides
an assertion letter to its board of directors that
confirms adherence to COSO standards.
In 2011, the Board of Governors engaged
Deloitte & Touche LLP (D&T) to audit the
combined and individual financial statements

of the Reserve Banks and those of the consolidated LLC entities.1 In 2011, D&T also conducted audits of internal control over financial
reporting for each of the Reserve Banks and
the consolidated LLC entities. Fees for D&T’s
services totaled $8 million, of which $2 million
was for the audits of the consolidated LLC
entities. To ensure auditor independence, the
Board of Governors requires that D&T be independent in all matters relating to the audits.
Specifically, D&T may not perform services for
the Reserve Banks or others that would place
it in a position of auditing its own work, making management decisions on behalf of the
Reserve Banks, or in any other way impairing
its audit independence. In 2011, the Bank did
not engage D&T for any nonaudit services.
The Federal Reserve Bank of Dallas’ financial
statements as of and for the years ended
December 31, 2011 and 2010 and the independent auditors’ report can be found at the
following link:
www.federalreserve.gov/monetarypolicy/files/
BSTDallasfinstmt2011.pdf

1
Each LLC will reimburse the Board of Governors for the fees related to the audit of its financial statements from the
entity’s available net assets.

Federal Reserve Bank of Dallas

32

2011 Annual Report

About the Dallas Fed
The Federal Reserve Bank of Dallas is
one of 12 regional Federal Reserve Banks in
the United States. Together with the Board
of Governors in Washington, D.C., these
organizations form the Federal Reserve System
and function as the nation’s central bank. The
System’s basic purpose is to provide a flow of
money and credit that will foster orderly economic growth and a stable dollar. In addition,
Federal Reserve Banks supervise banks and
bank holding companies and provide certain
financial services to the banking industry, the
federal government and the public.
The Federal Reserve Bank of Dallas has
served the financial institutions in the Eleventh
District since 1914. The district encompasses
360,000 square miles and comprises the state
of Texas, northern Louisiana and southern
New Mexico. The three branch offices of the
Dallas Fed are in El Paso, Houston and San
Antonio.
Federal Reserve Bank of Dallas
2200 North Pearl Street, Dallas, TX 75201
214-922-6000
El Paso Branch
301 East Main Street, El Paso, TX 79901
915-521-5200
Houston Branch
1801 Allen Parkway, Houston, TX 77019
713-483-3000
San Antonio Branch
126 East Nueva Street, San Antonio, TX 78204
210-978-1200
Website
www.dallasfed.org
Carol Dirks
Publications Director
Michael Weiss
Editor
Jennifer Afflerbach
Associate Editor
Gene Autry
Art Director and Photographer
Darcy Melton and Samantha Coplen
Illustrators