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THE FINANCIAL SAFETY NET: COSTS, BENEFITS, AND IMPLICATIONS FOR REGULATION 37TH ANNUAL CONFERENCE ON BANK STRUCTURE AND COMPETITION Chicago, Illinois May 10, 2001 ..................................................................... Welcoming Remarks Good morning. I’m Michael Moskow, president and CEO of the Federal Reserve Bank of Chicago. I’d like to welcome you to the 37th Annual Conference on Bank Structure and Competition. We have a great turnout and an outstanding line-up of speakers to discuss this year’s topic — “The Financial Safety Net: Costs, Benefits, and Implications for Regulation. This is an especially timely topic—particularly the focus on costs and benefits. Unfortunately, I think it’s fair to say that the general public has a better understanding of the benefits than the costs. The very term “safety net” has a positive connotation for many—who can oppose a cushion against unexpected hard times? Mention the financial safety net and you conjure up images like the one in the Chicago Fed’s Visitors Center. It’s a photo of a run on the Milwaukee Avenue State Bank on August 7, 1906. The Bank’s president left depositors high and dry after losing money in real estate and fleeing to Tangiers. Reporting on the event, the Chicago Tribune noted that “men and women knelt and prayed in the streets that their money be returned to them.” The safety net has provided some real benefits such as shielding less sophisticated depositors. Yet many would agree there are also costs—some significant costs. It’s interesting to recall that these costs were not unanticipated. Bankers generally opposed the introduction of deposit insurance and Franklin D. Roosevelt warned that it would “put a premium on unsound banking in the future.” For most people, the safety net means federal deposit insurance — undoubtedly an important component of the safety net. But clearly the scope of the safety net extends well beyond the stated coverage provided by the deposit insurance funds. Any thorough discussion of the financial safety net would include both 376 Michael Moskow Speeches 2001 implicit and explicit guarantees, the means by which those guarantees are delivered, and the changes in behavior resulting from those guarantees. In recent years there’s been increased public scrutiny of the financial safety net. Last year, for example, the FDIC initiated a comprehensive review of the deposit insurance system. Deposit insurance reform will be a key topic at the conference and we’re fortunate to have with us some of the leading experts in this area. We will also be discussing government-sponsored-enterprises or GSEs. Fannie Mae and Freddie Mac have been under close scrutiny recently by both Congress and the financial industry. And there have been similar concerns about the Federal Home Loan Banks. The conference will also focus on perhaps the most vexing public policy issue related to the safety net — the persistent expectation that large banks may be “too big to fail.” In addition we’ll discuss the safety net implications of the increasingly international nature of banking and the broader powers granted to depository institutionsâ??trends which have added new layers of complexity to an already difficult issue. This year’s “safety net” topic returns us to a theme that first emerged during the early 1980s when some of the first public policy discussions on moral hazard took place at the Bank Structure Conferences. Over the years there have been many major issues to discuss at the conference. Often conference debate preceded changes in public policy by a number of years. Our first Bank Structure Conference in 1963 looked at current research in the microeconomics of financial markets. During the early 1970s, the conference emphasized deregulation and the potential risks of existing regulatory arrangements. Later in the decade, we focused on a broader array of issues including risk management, measuring bank soundness, and the causes and consequences of bank failures. The overriding issue during the 1980s became the financial safety net, with a significant focus on the need to replace or supplement regulatory discipline with market discipline. It was during the early 1980s that the conference expanded to include academics, regulators, and industry participants — a change that has led to better, more relevant policy discussions. In recent years, we’ve focused on the changing nature of financial services and the increase in non-bank competition. With this conference we return to safety net issues. Many of the fundamental questions raised two decades ago are still with us, but with a contemporary twist. Among the key questions that we’ll be discussing are: • Has the safety net expanded in recent years? • Are regulators and legislators prepared to introduce true reform to the deposit insurance scheme? • What are the implications of such reform for small banks, which apparently have been having problems attracting the deposits that are fundamental to their success? • How can GSE oversight best be handled? • What is the extent of the subsidy associated with current government guarantees? How is market behavior altered as a result of this subsidy? Michael Moskow Speeches 2001 377 • And, finally, if markets believe a “too-big-to-fail” policy is still in effect, what are the resulting market distortions? All of these issues will have a critical impact on the financial services industry. I can’t think of a better person to launch these discussions then our keynote speaker, Alan Greenspan. Alan has been generous enough to serve as the keynote since he was appointed Chairman, in 1987 and he has always provided an outstanding start to the sessions. I won’t take Alan’s time with a lengthy introduction—I think everyone in this room is well acquainted with his many accomplishments and achievements. I would simply note that Alan is highly respected for his tremendous leadership, intellect and integrity. Naturally, he receives many tributes of various types. The Wall Street Journal recently summed up Alan’s sterling reputation by describing him as “the one economist whose opinions actually count. A tribute of another type came from a local source right here in the Chicago area. Earlier this year, the Chicago suburb of Arlington Heights became the first in the country to name a street after Alan, albeit temporarily. A green and white sign—appropriately enough the color of money—was posted last summer marking Alan Greenspan Way. The sign was largely the idea of an Arlington Heights resident, Al Smith, who got the idea after Chicago named a street for Hugh Hefner. I couldn’t agree more with his logic. In fact, if Hefner merits a street, then there is no boulevard grand enough to bear Alan Greenspan’s name. Alan’s leadership of the Federal Reserve over the last decade has been nothing short of stellar. It’s truly a great honor to have the Chairman as our keynote speaker. Please join me in welcoming Alan Greenspan. 378 Michael Moskow Speeches 2001
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