View original document

The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.

Vol. 5, No. 3
APRIL 2010­­

Insights from the

Federal Reserve Bank of Dall as

Regulatory and Monetary Policies
Meet ‘Too Big to Fail’
by Harvey Rosenblum, Jessica J. Renier and Richard Alm

In 2010, the U.S.

	Not too long ago, conventional wisdom in academic and central

economy has been

banking circles held that monetary policy had become increasingly effective

showing signs of

the past quarter century. Growth had become steadier. Recessions were shorter

pulling out of its

and less frequent. Inflation rates in much of the world had converged to low

tailspin. But questions

and relatively stable levels. This complacent view was shattered the past two

remain about why

years as a global financial crisis and severe recession raised doubts about

it took so much

central banks’ performance.

monetary policy

To combat the crisis, the Federal Reserve put the target federal funds

firepower to deal

rate on a downward trajectory, taking it to near zero by year-end 2008. By it-

with the crisis.

self, this traditional monetary policy stimulus proved insufficient to stem the
output and employment declines or to reduce financial instability. So the Fed
took the boldest policy actions in its 96-year history.

In 2008, the central bank created
several special lending facilities that
bypassed traditional financial channels
for providing credit to the private sector in the U.S. and abroad. In 2009, it
augmented the monetary stimulus with
quantitative easing, a strategy of reducing longer-term interest rates through
purchases of assets such as Treasuries
and mortgage-backed securities.
In 2010, the U.S. economy has
been showing signs of pulling out of
its tailspin. But questions remain about
why it took so much monetary policy
firepower to deal with the crisis.
We look for answers in the financial channels that transmit monetary
policy to the real economy and the
regulatory scheme designed to keep
the banking system sound. The channels clogged when the regulatory
apparatus didn’t ensure that banks
were healthy enough to lend—a situation exacerbated by the growing influence of very large, systemically important financial institutions, the so-called
too-big-to-fail banks.
How It Should Be
Monetary and regulatory policies
operate in tandem to facilitate the money
and credit flows vital to a modern economy. Central banks conduct monetary
policy with an eye toward providing
the macroeconomic stability and liquidity that encourage financial institutions
to lend to businesses and consumers.
Financial regulators strive to ensure
lenders don’t take on excessive risk.
Before examining monetary and
regulatory policies in the crisis, we will
review how they’re designed to work.
Monetary policy. The Fed
typically influences economic activity
through the target federal funds rate,
the interest rate that banks charge one
another for unsecured overnight loans.
The Federal Open Market Committee
(FOMC) meets every six weeks or so to
decide whether to increase, decrease or
stand pat on this primary policy lever.
Federal funds rate changes impact
the constellation of market interest
rates, working primarily through the

banking and financial system. Over
time, movements in market interest
rates impact real economic activity
through four primary channels.1
When the FOMC adjusts the
federal funds rate, banks’ cost of
funds rises or falls in tandem with that
rate. Financial institutions respond by
revising the terms and conditions on
loans they offer borrowers, creating a
bank loan channel that alters credit
availability throughout the economy.
The price and availability of credit
influence buying and investment
decisions, slowing or speeding up
overall economic activity.
A securities market channel
operates through money and capital
markets, where interest rates generally move in the same direction as the
federal funds rate. Changes in the price
and availability of nonbank financing
influence the borrowing decisions that
determine larger businesses’ employment and output decisions. Smaller
companies and individuals usually
borrow from banks and other financial
An asset prices and wealth
channel works through interest rate
changes’ effect on market prices for a
range of assets—such as bonds, equities, and homes and other real estate.
Consumers and businesses carry these
assets on their balance sheets and use
them as collateral for loans. Changes in
borrowing capacity directly affect credit
use. The perceived value of the assets
also factors into households’ decisions
to spend, borrow and save out of current income.
Finally, interest rate changes
impact the relative attractiveness of U.S.
investments, creating an exchange rate
channel. When rates rise or fall faster
in the U.S. than in other countries,
foreign investors respond by acquiring or divesting dollar-denominated
assets. These transactions alter currency
values, which in turn affect the relative prices of imports and exports. The
price changes filter through to demand
for goods and services, affecting overall economic activity.

EconomicLetter 2

Federal Reserve Bank of Dall as

These four channels summarize
how economic textbooks describe
monetary policy’s impact on the real
economy. For the most part, the textbooks get it right—at least for the
quarter century of highly effective
monetary policy.
The channels’ proper functioning led Gordon Sellon, the Kansas
City Fed’s former director of research,
to write in 2002: “Bank lending rates
on consumer and business loans and
mortgage rates now appear to exhibit
a much stronger and faster response
to monetary policy actions than in the
past. Moreover, institutional changes,
such as the increased use of variablerate loans and the availability of lowcost mortgage refinancing, may have
altered the transmission mechanism,
potentially broadening the influence
of monetary policy on the economy.”2
Sellon’s observation reflects a conventional wisdom that was right on—at
the time. However, monetary policy’s
channels function smoothly only when
banks hold enough capital to safeguard
against bad loans and other risks. Wellcapitalized banks can expand credit to
the private sector in concert with monetary policy easing. Undercapitalized
banks are in no position to lend money
to the private sector, sapping the effectiveness of monetary policy.
The bank capital linkage completes the financial market architecture
of effective monetary policy (Figure
1).3 However, it’s regulatory policy—
not monetary policy—that focuses on
ensuring banks maintain healthy capital ratios.
Regulatory policy. History
teaches us that financial markets—particularly unregulated ones—experience
the exuberance of excess risk-taking
in boom times, followed by the pain
of hard landings. When busts occur,
bank failures are particularly unsettling because they can have devastating effects on consumers, companies,
industries and even the economy as a
For these reasons, all modern
economies seek to ensure the safety

and soundness of the financial industry. Regulation entails setting rules for
institutions’ operations, activities and
ownership. Supervision involves monitoring them to verify that they comply
with the regulations.
The Fed shares regulatory and
supervisory duties with the Comptroller
of the Currency, Federal Deposit
Insurance Corp. (FDIC) and Office
of Thrift Supervision. The financial
institution’s charter largely determines
each agency’s responsibilities. The
Fed’s regulatory responsibility lies with
bank holding companies, those statechartered banks that have chosen to be
under Fed supervision and some foreign banking operations in the U.S.
The savings and loan crisis of
the 1980s prompted regulatory reform
designed to preserve the solvency
of federal deposit insurance and to
restore confidence in the banking
system. The resulting legislation mandated an approach, dubbed prompt

corrective action (PCA), designed to
remedy banks’ potential balance-sheet
problems before they could fester.4 It
requires undercapitalized banks to take
immediate steps to restore their financial integrity.
To be considered well-capitalized, banks are required to maintain
capital-to-risk-weighted asset ratios
of at least 10 percent. In hard times,
higher-than-anticipated loan losses can
force banks to take writedowns that
erode their capital bases. When the
key capital ratio slips below 8 percent,
regulators begin to invoke a series of
PCA procedures that include restraining asset growth. Once the ratio falls
below 6 percent, banks face further
requirements that include raising equity
capital and restricting dividends and
bonuses. Taking these actions forces
banks to replenish their capital bases,
restoring their capacity to lend.
Some troubled banks may be too
weak for this kind of remedial action.

Over time, movements
in market interest rates
impact real economic
activity through four
primary channels.

Figure 1

The Channels from Monetary Policy to the Economy:
Monetary and Bank Regulatory Policies Aren’t Independent but Work in Tandem
regulatory policy

Monetary policy
Fed funds rate
Market interest rates

Bank capital

Bank loan

market channel

Asset prices and
wealth channel

• Interest rates
• Credit standards

• Interest rates
• Debt issuance

• Collateral values
• Net worth

Federal Reserve Bank of Dall as

3 EconomicLetter


rate channel

Widespread jitters
sent the cost of raising
new capital through
the roof, reinforcing a
lesson of past crises:
Capital is prohibitively
expensive when
needed most.

PCA requires that critically undercapitalized banks enter receivership or be
sold while still solvent, thereby minimizing losses to the FDIC.
PCA breaks down if troubled
banks are overlooked or undiscovered
by regulators. Loan losses worsen,
leading to tighter lending standards
and slower or even declining lending
activity. Scarce credit slows economic
growth, bringing about new rounds
of loan losses and writedowns among
a widening circle of banks. And on it
goes, eventually leading to hardship
for the overall economy.
When functioning properly, PCA
alleviates banking problems before
they grow big enough to threaten the
economy. However, problems arise
when PCA doesn’t live up to its name.
Enter ‘Too Big to Fail’
Regulatory action that’s both
prompt and corrective should go a long
way toward reducing the risk of entering the downward spiral of credit and
economic activity that can follow loan
losses and writedowns. The macroeconomic spillovers that threaten economic
stability come from delayed corrective
action, which allows troubled banks to
put off the painful task of getting their
balance sheets in order. The balance
sheet problems just worsen.
What interferes with PCA? For
starters, it could be a lot of banks getting into trouble at the same time—
victims of the same shock. Regulators
can’t carry out PCA at that many banks
quickly enough, and at least some
troubled banks will be left to deteriorate further.5 Instead of getting well,
the sick banks get sicker, tighten credit
standards and rein in lending. The
cumulative impact is slower growth in
the overall economy, causing additional
loan losses and feeding the downward
spiral of credit and economic activity.
Too-big-to-fail (TBTF) banks are
an even greater potential drag on PCA.
Our financial system has changed a
great deal since the introduction of
PCA. The past two decades’ financialmarket innovations and legislative

EconomicLetter 4

Federal Reserve Bank of Dall as

changes have allowed banks to operate nationwide, offer a wider range of
services and invest in riskier and ever
more complex financial instruments.6
This business environment has
fostered bigness. In 1990, the 10 largest U.S. banks had almost 25 percent
of the industry’s assets. Their share
grew to 44 percent in 2000 and almost
60 percent in 2009. The two biggest
banks in housing finance had 44 percent of U.S. mortgage originations in
2009, and the top four had 58 percent.
Mammoth financial institutions
confound regulation and supervision
because their operations are global,
highly complex and often opaque. As
the financial crisis unfolded, it became
evident that top managers at some
big banks didn’t thoroughly grasp
the risks involved in their institutions’
investment decisions.7 For supervisory
agencies, this overwhelming complexity makes determining the condition
of such banks an epic undertaking in
time and manpower—an obstacle to
the “prompt” in PCA.
Perhaps more important, putting
the “troubled bank” tag on a TBTF
institution has daunting consequences.
The biggest banks have tentacles that
reach deep into other financial institutions, industries and countries, creating
a potential for serious and unforeseen
consequences from PCA. Shutting
down a TBTF bank is a worst-case
scenario that involves immense cost—
directly for the FDIC and indirectly for
the economy.8
In the financial crisis that began in
2007, widespread mortgage loan losses
at banks led to massive writedowns.
The number of problem institutions
rose from 90 in first quarter 2008 to
702 in fourth quarter 2009.9 The assets
of those troubled institutions totaled
$403 billion, the equivalent of a few
large regional banks, suggesting that
none of the largest—i.e., TBTF—
banks ever reached the point of being
declared a problem bank or being subjected to PCA intervention.
Yet some of the largest banks
were no doubt crippled. The financial

press certainly knew of the problems.
Starting in early 2007, one article after
another told of industry giants suffering huge losses on what would eventually be described as “toxic assets”
(Table 1). Investors were also aware of
the problems. In 2007 and 2008, bank
stock prices plunged as the public
lost confidence in bank managers and
regulators (Chart 1).
What Went Awry
Facing rapidly deteriorating economic conditions in 2008, the Fed
turned to its traditional monetary
policy tool—the federal funds rate.
Policymakers assumed lower interest
rates and sharp increases in discountwindow lending would have a positive
impact on the real economy through
monetary policy’s transmission channels.
It didn’t happen. The macroeconomic imperative called for maintaining and expanding private-sector loans.
However, banks’ focus was microeconomic—the erosion of their capital
ratios. Banks faced an urgent need
to shore up balance sheets by raising
capital and selling or otherwise reducing assets. But widespread jitters sent
the cost of raising new capital through
the roof, reinforcing a lesson of past
crises: Capital is prohibitively expensive when needed most.
Banks’ diminished capacity to
lend had important implications for
monetary policy. The growing presence of undercapitalized banks blocked
the channels that transmit central bank
actions to the real economy. In time,
the FDIC could whittle down the
number of troubled banks by closing
and merging smaller institutions. What
the system couldn’t deal with was the
TBTF institutions, which by their nature
couldn’t be put out of business in the
midst of a financial crisis.
Troubled banks left in place clog
up monetary policy mechanisms. The
bank loan channel behaved perversely. The FOMC aggressively lowered the federal funds rate, anticipating
that interest rates on bank credit would
go down, too. In their efforts to ration

Table 1

Selected Timeline of Global Financial Industry Distress:
February 2007–January 2008
Feb. 8, 2007

Increase in bad home loans to high-risk borrowers in U.S.
shakes HSBC, heightens perceived risk of corporate debt

April 2, 2007

New Century Financial, a leading subprime mortgage lender,
files Chapter 11 bankruptcy

June 23–Aug. 2, 2007

Bear Stearns fights to save two ailing hedge funds by
pledging billions of dollars and suspending redemptions,
but it fails; both funds file for bankruptcy

Aug. 9, 2007

BNP Paribas, France’s largest bank, halts redemptions on
three investment funds after it is unable to value subprime
mortgage assets

Aug. 14, 2007

Goldman Sachs and investors inject $3 billion into the firm’s
flailing quantitative hedge fund

Sept. 14 –17, 2007

Northern Rock, the United Kingdom’s fifth-largest mortgage
lender, receives emergency funds from the Bank of England;
the government guarantees savings deposits

Oct. 5, 2007

Following similar warnings by Citigroup, UBS and Credit
Suisse, Merrill Lynch warns of major writedowns for bad
investments linked to U.S. subprime mortgage defaults;
Washington Mutual joins with warnings of major losses

Oct. 16, 2007

Citigroup begins a string of major writedowns based on
subprime mortgage loans

Oct. 24, 2007

Merrill Lynch announces an $8.4 billion writedown related
to mortgage losses

Oct. 30–Nov. 4, 2007

Merrill Lynch CEO Stanley O’Neal and Citigroup CEO Charles
Prince step down amid major losses

Nov. 13, 2007

Bank of America reveals need to write down $3 billion in
debt securities due to subprime mortgage defaults

Dec. 10, 2007

UBS posts a $10 billion writedown in debts linked to the
subprime U.S. mortgage sector

Dec. 14, 2007

Citigroup attempts to rescue seven structured investment
vehicles in $58 billion debt bailout

Dec. 20, 2007

Morgan Stanley takes a $9.4 billion writedown of assets and
sells a $5 billion stake to a Chinese sovereign wealth fund

Jan. 15–23, 2008

Bank of America joins the parade of firms with mortgagerelated losses, following Citigroup’s $22.2 billion writedown
and Merrill Lynch’s sale of a $6.6 billion stake to foreign

SOURCES: Federal Reserve Bank of New York timeline,;
Federal Reserve Bank of St. Louis timeline,; Credit Writedowns,

the limited capital remaining on their
balance sheets, however, banks facing
loan losses tightened credit standards
and retrenched, and the rates that mat-

Federal Reserve Bank of Dall as

ter most—those paid by businesses
and households—rose rather than fell,
thwarting the Fed’s goal of reducing
rates to stimulate the economy.

5 EconomicLetter

Chart 1

Bank Stock Prices Plunge Amid Turmoil
Index, Jan. 30, 2007 = 100


S&P 500

TARP passed


Bear Stearns
acquired by
J.P. Morgan




Selected bank
stock index
AIG loan
Entire market spooked














NOTE: Index based on average stock price of Citigroup Inc., Bank of America Corp. and J.P. Morgan Chase & Co.
TARP is the Troubled Asset Relief Program.
SOURCES: Bloomberg; New York Times; authors’ calculations.

The securities market channel
constricted because investors hunkered
down as the rapidly deteriorating conditions of many TBTF banks slowed
the economy and shattered overall
confidence. Toxic assets’ deadweight
impeded the flows of debt and equity
capital to businesses and consumers.
In past crises, large companies had
the alternative of issuing bonds when
troubled banks raised rates or curtailed
lending. This time, capital markets
offered little relief.10
When the crisis sent private-sector
interest rates up rather than down, the
value of homes, stocks, bonds and
other assets fell, impeding the asset
prices and wealth channel. In a flight
to cash, households and businesses
turned to balance sheet deleveraging—
that is, asset sales, even at unattractive
prices. Debt and new borrowing tumbled at the worst possible time.
The exchange rate channel failed
for several reasons. First, official policy
rates fell, but rising interest rates for
private-sector borrowers made U.S.
assets more attractive. Second, the

simultaneous drop in official policy
rates in other countries experiencing
similar financial problems reduced the
incentive for foreigners to purchase
U.S. assets, goods and services. Third,
investors fled to the safety of the U.S.
dollar, pushing its value up.11
Because of the blockages in these
channels, PCA was ineffective in an
era of TBTF banks (Figure 2). The
problems originated with several very
large, systemically important financial institutions that were experiencing similar shocks and hemorrhaging
losses. Because PCA loses its “prompt”
in the case of TBTF banks, problems
festered, causing negative spillovers in
the rest of the economy.
TBTF banks became the propagating mechanism for an adverse
feedback loop between the banking
system and the economy. As a result,
traditional monetary policy lost much
of its effectiveness. The obstructions in
monetary policy channels worsened a
recession that has been longer, deeper
and more painful than any post-World
War II slump.

EconomicLetter 6

Federal Reserve Bank of Dall as

With its conventional policy tools
blocked, the Fed resorted to unprecedented measures the past two years,
opening new channels to bypass the
blocked ones and restore the economy’s credit flows. While the extraordinary measures helped stabilize the
economy, the fact remains that monetary policy didn’t work as it should
have. In retrospect, it is clear that
TBTF financial institutions were clogging the channels vital to the proper
functioning of monetary policy.
Connecting the Dots
PCA is well-intentioned, but it
assumes that bank failures are isolated
events, a notion that made sense before
the banking system became so highly
concentrated and interconnected. Even
more problematic, PCA isn’t equipped
for the challenges of too-big-to-fail
financial institutions. When a lot of
banks are in trouble at once, or when
one or more TBTF institutions are tottering, efforts to keep the financial
system sound are delayed—with potentially serious implications for monetary
It may be possible to restore
promptness to PCA by expanding the
capacity for supervision and remedial
action—at least for non-TBTF banks
that run into problems. Until we
address issues surrounding TBTF, however, the biggest, most complex institutions will remain a potential danger
for two reasons. First, their size, geographic reach and complexity render
them too complex to manage. Second,
these characteristics make them an
overwhelming challenge for regulators. Supervisors must rely on the same
opaque and confounding accounting
and management information used by
the banks themselves.
Many ideas have been put forward
to reduce the threat of TBTF banks so
that they won’t undermine bank regulatory policies, frustrate monetary policy
and weaken the economy in the future.
Among the proposals: (a) increasing
capital, (b) reducing leverage and size,
(c) imposing product limitations, (d)

enhancing supervision, (e) improving
market discipline and (f) breaking up
TBTF institutions before the next crisis.12
While any of these proposals
might help, there’s no doubt risk management needs improvement, perhaps
as part of a regulatory and supervisory
overhaul. The merits of imposing controls over the freewheeling and unregulated segments of the financial services
industry, often called the shadow banking system, also deserve some focus
and debate.13 Clearly, some combination of these general reform recommendations is needed to reduce the
probability, frequency and magnitude
of future financial bubbles.
Even if we reduce the TBTF
threat, monetary policy will still depend
heavily on effective regulatory policy.
Transmitting the Fed’s actions to the

real economy requires sound financial
institutions that are well-capitalized and
willing to lend. It’s the job of regulation
and supervision to weed out the weak
banks so their inability to lend doesn’t
block monetary policy channels.
This reliance on well-functioning
banks gives central bankers a vital
need for precisely targeted, real-time
data on the health of the financial
system and the institutions within it.
These data can affect central bank
decisions such as the timing, strength
and tactics of monetary policy actions,
including lender-of-last-resort policies
and decisions. Incomplete or dated
information increases the chances for
Monetary and regulatory policies
are inseparable. The Fed’s supervisory
role puts the central bank’s finger

directly on the pulse of the financial
system, providing a tool that serves
the goal of effective monetary policymaking. While the Fed has accepted
criticism for failing to detect potential
problems prior to the crisis, the failure only highlights the need for better
integration of monetary and regulatory
policies. Stripping the Fed of regulatory
functions would compromise the conduct of monetary policy.
Rosenblum is executive vice president
and director of research at the Federal
Reserve Bank of Dallas. Renier is senior
economic analyst and coordinator
of economic and financial analysis
in the bank’s Research Department.
Alm is writer in residence at Southern
Methodist University’s O’Neil Center for
Global Markets and Freedom.

Figure 2

Monetary Policy Channels Blocked in Crisis, Especially in Era of Too-Big-to-Fail Banks
regulatory policy

Monetary policy

Fed funds rate
Market interest rates

Bank capital


Bank loan

market channel

Asset prices and
wealth channel

• Interest rates
• Credit standards

• Interest rates
• Debt issuance

• Collateral values
• Net worth

rate channel


When banks are undercapitalized, an adverse feedback loop of tightening credit directly affects terms of bank loans, the
securities market and asset prices, thus undermining official interest rate policy. These same channels, along with the
exchange rate, are adversely affected in indirect ways through sticky market interest rates as a result of bank retrenchment.
If undercapitalized, too-big-to-fail banks are major obstacles to effective monetary policy because of their size, complexity
and resistance to regulatory remedies.

Federal Reserve Bank of Dall as

7 EconomicLetter


See “The Monetary Transmission Mechanism:

company doesn’t have strong risk management
controls and a strong culture of enterprise-wide

Some Answers and Further Questions,” by Ken-

risk management, I think that would be also

neth N. Kuttner and Patricia C. Mosser, Federal

grounds for the supervisor requesting either

Reserve Bank of New York Economic Policy

substantial strengthening in those controls or

Review, May 2002, pp. 15–26.

eliminating those activities.”


See “The Changing U.S. Financial System:


Finding a healthy bank that is willing and able

Some Implications for the Monetary Transmis-

to be a merger partner for a very large troubled

sion Mechanism,” by Gordon H. Sellon Jr.,

bank can be particularly difficult in the midst of

Federal Reserve Bank of Kansas City Economic

a financial crisis when many banks are already

Review, First Quarter, 2002, pp. 5–35.

hobbled by the same shocks and overall eco-


See “Explaining Bank Credit Crunches and

nomic weakness. The problem is compounded

Procyclicality,” by Robert R. Bliss and George

when the financial crisis spreads globally.

G. Kaufman, Federal Reserve Bank of Chicago


Chicago Fed Letter, no. 179, July 2002.



Federal Deposit Insurance Corporation Improve-

FDIC Quarterly Banking Profile, Fourth Quarter,


See In Fed We Trust, by David Wessel, New

ment Act of 1991,

York: Crown Publishing Group, 2009, pp. 102–03.




In the 1980s savings and loan crisis, Richard

The strength of a currency also reflects percep-

tions about the relative financial strength of each

Breeden, chairman of the Federal Savings and

country’s banking system because, after all, one’s

Loan Insurance Corp., told the press his agency

ability to obtain currency is dependent upon a

had the capacity to close only three S&Ls a

bank’s ability to honor its obligation to depositors

week, putting an effective cap on the number

to convert bank deposits into cash. This obliga-

of institutions that could be shuttered. Until

tion is dependent upon the perceived robustness

the week of June 26, 2009, when the Federal

of the nation’s deposit insurance system. In the

Deposit Insurance Corp. (FDIC) began closing an

U.S., the FDIC’s reputation is unparalleled for

increased number of banks on a sustained basis

quickly paying depositors the full amount of their

(as many as nine banks in one week), it appeared

deposits, up to the insured limits. As a result, it is

as though the FDIC would face similar capacity

no accident that a flight to safety during banking


and financial panics is much the same as a flight


The Glass–Steagall Act of 1933 and Bank

Holding Company Act of 1956 had prohibited a

to U.S. dollar deposits.

See “The Blob That Ate Monetary Policy,” by

single institution from acting as a combination

Richard Fisher and Harvey Rosenblum, Wall

investment bank, commercial bank and insurance

Street Journal, Sept 28, 2009; “Paradise Lost:

company. In 1999, the Gramm–Leach–Bliley Act

Addressing ‘Too Big to Fail’ (With Reference

opened up the market to allow such combi-

to John Milton and Irving Kristol),” speech by

nations within a financial holding company,

Richard Fisher, president and CEO of the Federal

although these entities still cannot own nonfinan-

Reserve Bank of Dallas, Nov. 19, 2009; “Lessons

cial firms. Moreover, the Riegle–Neal Interstate

Learned, Convictions Confirmed,” speech by

Banking and Branching Efficiency Act of 1994

Richard Fisher, March 3, 2010; and “The $100

eliminated most restrictions on interstate banking

Billion Question,” speech by Andrew G. Haldane,

and branching.

executive director, financial stability, at the Bank


In answer to questions during testimony before

of England, March 2010. As of this writing,

Congress on Feb. 25, 2010, Fed Chairman Ben

numerous proposals to address TBTF financial

Bernanke explained the difficulties supervisors

institutions were making their way through the

have in assessing risks faced by institutions that

U.S. Congress.

even corporate managers didn’t fully compre-


hend: “In the previous crisis we really learned

within the shadows of traditional commercial

that many large, complex companies didn’t really

banking—including hedge funds owned and

understand the full range of risks that they were

operated by commercial banks.

facing. And as a result, they found themselves
exposed in ways they didn’t anticipate. So if a

is published by the
Federal Reserve Bank of Dallas. The views expressed
are those of the authors and should not be attributed
to the Federal Reserve Bank of Dallas or the Federal
Reserve System.
Articles may be reprinted on the condition that
the source is credited and a copy is provided to the
Research Department of the Federal Reserve Bank of
Economic Letter is available free of charge
by writing the Public Affairs Department, Federal
Reserve Bank of Dallas, P.O. Box 655906, Dallas, TX
75265-5906; by fax at 214-922-5268; or by telephone
at 214-922-5254. This publication is available on the
Dallas Fed website,

Richard W. Fisher
President and Chief Executive Officer
Helen E. Holcomb
First Vice President and Chief Operating Officer
Harvey Rosenblum
Executive Vice President and Director of Research
Robert D. Hankins
Executive Vice President, Banking Supervision
Director of Research Publications
Mine Yücel
Executive Editor
Jim Dolmas
Richard Alm
Associate Editor
Kathy Thacker
Graphic Designer
Ellah Piña

Parts of the shadow banking system exist even

Federal Reserve Bank of Dallas
2200 N. Pearl St.
Dallas, TX 75201