Hoenig Stirs Debate on Bank Failures as Fed Forum Convenes

By Scott Lanman

Aug. 20 (Bloomberg) -- The host for central bankers attending the Federal Reserve conference this weekend to discuss the financial crisis is a regional Fed chief who’s making waves with his proposal for letting big U.S. banks fail.

Thomas Hoenig, the Kansas City Fed president, will welcome Fed Chairman Ben S. Bernanke, European Central Bank President Jean-Claude Trichet and dozens of other central bankers to the annual symposium in Jackson Hole, Wyoming, starting today. Hoenig said he hopes the gathering will serve as a model for handling crises in the future.

Bernanke has urged Congress to back part of Hoenig’s proposal for dealing with faltering big banks, which would wipe out shareholder equity in any that receive government aid. The Treasury Department’s so-called resolution authority plan, while likely to result in stockholder losses, doesn’t require it.

“Tom is leading the mainstream on this,” said former Fed Governor Lyle Gramley, now senior economic adviser with New York-based Soleil Securities Corp. “He’s ahead of the curve.”

Hoenig, 62, took office in 1991 and is soon to be the longest-serving Fed policy maker. Out of the 12 regional Fed presidents, he is one of two to have served as a head of bank supervision. Hoenig is tougher than his colleagues on inflation, having dissented from interest-rate votes four times since 1995, always for tighter policy.

Alternative to Bailouts

Companies with weak capital or investor confidence shouldn’t be bailed out, Hoenig said in a private talk in Omaha, Nebraska, in March. He said the government instead should declare them insolvent, replace managers, remove the bad assets and require shareholders to take losses. Hoenig broke from his usual practice of speaking from notes on index cards for non- economic comments and released written text entitled “Too Big Has Failed.”

Senator Sam Brownback of Kansas asked for a copy of the speech after reading a newspaper article about it. He invited Hoenig to testify at an April hearing of the Joint Economic Committee, where Brownback is the ranking Senate Republican. Brownback said he had received “huge numbers of calls” from constituents angry about bank bailouts.

“Tom putting it out there, said, ‘You’re frustrated and you’re mad and there’s a way to address it,’” Brownback said in an interview. “It gave it, I think, a realistic, regulator approach from a respected individual.” He said he would like Hoenig to address lawmakers again this year.

The debate has been fueled by multibillion dollar government rescues of financial companies including Citigroup Inc. and American International Group Inc. Lawmakers in line with Hoenig include Alabama Senator Richard Shelby, the top Republican on the Banking Committee.

Shifting Risk

“Our regulatory reform effort must place the risk back where it belongs, on the risk takers and not on the taxpayers,” Shelby said in a statement.

Bernanke echoed Hoenig’s views in recent congressional testimony. In July 24 remarks to the House Financial Services Committee, the Fed chief indicated support for the Treasury’s resolution plan while adding that Congress might want to add some constraints such as requiring shareholders to bear losses.

“People are starting to sit up and take notice of his remarks,” said Camden Fine, president of Independent Community Bankers of America, a Washington-based trade group. “It’s influencing the debate.”

Not everybody agrees with Hoenig’s recommendation of setting strict guidelines to handle financial failures.

“You have to trust the authorities with some ability to change the rules when they need to,” said William Isaac, former head of the Federal Deposit Insurance Corp. and now chairman of the global financial services unit of LECG Corp., an economic and financial consulting company based in Emeryville, California.

Vigorous Debate

While Hoenig’s plan may not be covered in the formal discussions at Jackson Hole, his fingerprints extend past the brief remarks he delivers: Hoenig approves topics and speakers, with an eye to fostering debate.

“It has to be vigorous,” Hoenig said during an interview in a conference room next to his 14th-floor office at the bank’s new limestone-and-glass headquarters building in Kansas City. “I don’t think we’ll get better if we don’t listen to our critics as well as to those who praise us.”

Scheduled speakers include Bernanke tomorrow, along with Trichet, Bank of Japan Governor Masaaki Shirakawa, and less- well-known professors such as Carl Walsh of the University of California at Santa Cruz and Ricardo Caballero, chairman of the Massachusetts Institute of Technology’s economics department.

“I’m hoping that this becomes, in a sense, a lessons- learned and a beginning of a blueprint,” Hoenig said.

Roots in Iowa

Thomas Michael Hoenig grew up in Fort Madison, Iowa, the second of seven children of a plumber and homemaker. After being drafted into the Army and serving in Vietnam, he completed graduate studies in economics at Iowa State University in Ames. Unlike most students, Hoenig was ready with his dissertation topic, bank competition.

“He decided what he wanted to write his dissertation on and came in and told me,” recalled Dudley Luckett, a retired professor who was Hoenig’s adviser.

Hoenig joined the Kansas City Fed as an economist in 1973. He played basketball there with another young economist, Donald Kohn, who’s now the central bank’s vice chairman.

One of Hoenig’s defining experiences occurred in 1982, when he was on the front lines during the failure of Oklahoma City’s Penn Square Bank, which triggered a national banking crisis and helped precipitate the 1984 government takeover of Continental Illinois National Bank & Trust Co.

Principles Approach

“We learned lessons about concentrations of credit,” Hoenig said. That and subsequent events helped shape his view that setting hard rules for banks was better than the so-called principles-based approach, which favors wide-ranging edicts such as treating customers fairly. The U.K.’s financial regulator held itself out as a principles-based regulator until this year.

“There’s nothing in this crisis that I haven’t seen before,” Hoenig said.

Warning about dangers posed by big banks isn’t new for Hoenig. In a 1999 speech, Hoenig said the rise of “mega financial institutions” created a risk of a “less stable and a less efficient financial system” because the government would be reluctant to close troubled companies, creating implicit guarantees for some depositors and creditors.

Hoenig will become the longest-serving Fed policy maker this year when Minneapolis Fed President Gary Stern, who has also made a name studying too-big-to-fail, retires.

“I don’t ever recall him being so vocal on a subject like this,” said Douglas Lee, who runs Economics from Washington, a consulting firm in Potomac, Maryland. “He will certainly be a voice that will be listened to.”

To contact the reporter on this story: Scott Lanman in Washington at slanman@bloomberg.net.