FDIC's Hoenig: A Myth That Capital Undermines Growth (Audio)

think it's productive. But I do think the case for removing accommodation is strengthening. Stocks are trading lawer. The SMP five hundred index down three to seventy two, a drop there of two tenths of one percent. Down Industrials down thirty three, a decline also of two tenths of one percent. NASA stackdown six, a drop of one tenth of one percent. The tenure down four thirty seconds had yield one point five seven percent. Gold down three seventy to thirty two,

a drop of three tenths of one percent. Crude oil West Texas Intermediate up one point six Right now on West Texas Enemedia Crude. I'm Charlie Pellett. That's a Bloomberg Business Flash. This is taking Stock with Kathleen Hayes and Pim Fox line from the Jackson Hole Economic Symposium on Bloomberg Radio. This is taking Stock. I'm Pim Fox at Bloomberg World headquarters in New York and my colleague and co host Kathleen Hayes on site in Jackson Hole, Wyoming.

Joining us now is Thomas Hanneck. He is Vice chairman of the Federal Deposit Insurance Corporation. He was formerly the eighth Chief Executive of the tenth District Federal Reserve Bank in Kansas City, and he served as a voting member of the Federal Open Market Committee. And he joins us now.

Mr Hannick, what if you could comment on the banking situation as it relates to capital reserves and whether there is any contradiction between the desire to have banks lend money in a low interest rate environment on the one hand, but on the other hold them to higher capital standards which may indeed prevent them from lending the very money you hope to get into the system. Well, that's a very good question. And thank you for having me on your program. And let me begin by telling you that

capital is not a reserve. Capital is lendable funds. And what we're trying to do is make sure that there is enough ownership capital, that is, enough ownership funds lending out there that makes the financial system safer. What you do and what the objective is when you allow your capital levels to fall, that is your ownership interest to fall, is you're allowing that ownership to leverage up their position,

increasing the risk of the institution. And so should it run into difficulty, it has less margin for air, less margin for mistakes, and that can precipitate a downturn in the economy or in the precipitative crisis, as we've learned in the last crisis. So capital is very useful in terms of holding people responsible for the quality of the institution,

and I think it has a very positive outcome. Let me also note for you that um those institutions, there's increasing evidence of recent study by the Followers Bank of New York as a matter of fact, that UH and also by the b I S that institutions that have higher capital levels are able to continue to lend during the downturn because they don't have the pressure to keep their capital ratios, that is the amount of capital they have two assets, uh to unusually to higher levels, are

to the same levels as they increase their losses, and they can hold their customers and keep their customers funded during that period, and that helps mitigate the crisis. So capital is actually a very good thing, um, and I think to call it a reserve as if you put

it aside or something is a mistake. Is lendable funds very productive, just like any other form of lendable funds and we need to keep that in mind well, of course, and of course PIM prefaces with the idea I think remplicitly that this makes it makes it harder for banks to lend and it is a drag on growth. Uh. Do you disagree with that? Is it, more broadly just too much regulation from Dodd? Frank, I absolutely disagree with that.

Capital is proven to be Let me, let me just give you an example of where you were wrong under under a highly leveraged situation where you use risk based capital and you say, all right, these are low risk sovereign depth rest loans and so forth, so you lend to those people because there's no capital requirement there and loans who you have to hold more capital against you say, uh, they go unfunded, although they may be the better return uh,

and therefore facilitate growth. And like I said, we've learned over and over again and that institutions that are well capitalized usually compete better. They can take on risk more aggressively because they have more capital, they can afford to make the mistake, and therefore it turns out to be much more supportive. And in fact, the b I S and its studies show that with higher capital levels we

saw increases in lending, not decreases. So this, this myth that requiring capital is a bad thing is hurting the economy in the long run. It makes it less stable, more susceptible to contagion because when you have more capital, if one bank fails, it doesn't have to spill over to the next. Uh. Those are all things that capital serves purpose for. And I think it's, like I say,

a myth to say that capital undermines growth in the economy. Um, now that doesn't mean you can't have borrowing, you shouldn't have leverage. That's very much a part of any economic situation or any economic growth, uh concept. At the same time, too little capital is destabilizing, and that's what you have to keep in mind. Mr har No no no no. Are just gonna say if you could comment on what you see as some of the fundamental issues facing the

international banking system, particularly banks in Europe. Well, Europe has a couple of things going on. They first of all, tend to have less tangible capital than US banks, not a whole lot less, but less capital. And they have more as i'm as I read the i m F type reports, they have more legacy problem assets that they have to continue to deal with. And so that that's you know, that's a bad combination. That's capital more legacy problem assets, and you that that constricts your ability to

lend and to grow. And I think we're seeing some of that effect Europe at this point. I think should they continue to weaken their capital in the name of growth, I think they'll actually have a perverse effect of actually waking their growth in the long run. But those are

decisions they have. I think the United States has gained market share I'm told is that read the Financial Times because we as a as an industry in this part of the world are competing from a stronger position, that is, more capital, and I think that served this well and I think they should perhaps um look at that and see how that might infect improve their situation with more capital and working through their legacy problem assets tom uh

Italian banks, non performing loans, many dark clouds homing hanging over their banks. I can understand how to maybe certainly an issue for Italy it's financial system and economy broadly within the OW area, and for the ECB on its problem or worry list. What about for the United States? Though?

Is there any kind of financial risk from Europe? Europe's banking problems which are getting more and more attention, and our financial system in our markets, well, I think there's always the issue of contagion across continents because they're inner inter linked, not only with trade but with financial capital flows and so forth, so we have to be mindful

of that. I think the US banks are pretty well positioned to uh handle some of that more successfully than say other countries, because we do have a little not a little, We do have a stronger capital position. I have argued and continue to argue our capital needs to be stronger. Yet that that would only help us in the long run. UM, But we are better positioned than other countries to withstand. We have less exposure to it number one, we have stronger capital number two, and I

think those are big advantages over the long run. Mr Hannag, I want to just pick up on this idea of perhaps a relative world. UM. We've had many guests on the program who say that the bond market is currently distorted, that because of the relative high yield of US treasuries, money is flowing into treasuries for all the wrong reasons. What are your thoughts about distortion and bond interest rates and why bond prices have been going higher and higher. Well,

there's a many, many elements of distortions. One of the elements of distortions is unusually low interest rates for eight years year interest rates are not normal under any definition of normal. This causes a reallocation of capital, movement of capital. And then you then, I use the often comparison of if you're grading on a curve the dollar and the US financial system is relatively stronger. Where do you put

your money when you're uncertain? You put it where you have the greatest confidence, and that's in the us still. So those are the things that are affecting us. I want to ask you just one final question, Tom about bank regulations. This is an election year. There's all in the talk, and there's been talking last years more regulation, you know, put more regulation on, no, no, no, pull back last eagle. You're the vice chair of the f d i C. What do you think about what is

needed or not needed? Now? Well, I think that's a very good question. I think um number one, that the largest institutions are incredibly large. They are too big to fail. We're not going to solve that time that anytime soon. And I think with that environment, you're going to have more regulation. Do we need more regular, more regulation to what we already have? The answers, No, we have tons

of regulation. One of the things that I'm proposing is for what I refer to as simpler banks, more traditional banks where you're lending basically and taking deposits and not in the investment banking broken bank, that you really do get some substantial regulatory relief in place around capital, around lending, qualified mortgages, and so forth. And we do need to think about how we take some of this burden off the regional and smaller banks UH as soon as we can.

Tom Hanig, thank you so very much. We're gonna have to come back and continue this conversation. Tom Hanig is the former president of the Federalist of Bank of Kansas City. He is the vice chair of the Federal Deposit Insurance Corporation. This is Bloomberg.