The FDIC resolution regime, he says, does not put creditors at banks at sufficient risk of facing losses

TO BE NOTED: From Real Time Economics:

"By Sudeep Reddy

Gary Stern, president of the Federal Reserve Bank of Minneapolis, has had the ultimate I-told-you-so year at the central bank.

His book, “Too Big To Fail: The Hazards of Bank Bailouts,” addresses the problems that arise when banks become too large, create risks to the financial system and then require government rescues to save the economy.

Stern

The book originally came out five years ago. That’s at least four years before bailouts of Bear Stearns, Citigroup, Bank of America, AIG and hundreds of banks that have received government money to help stay afloat.

In a speech at the Brookings Institution today, Stern kicked off his remarks (titled “Better Late Than Never”) with this line: “Destiny did not require society to bear the cost of the current financial crisis.”

Brookings this year is re-releasing the book (by Stern and co-author Ron Feldman), but Stern doesn’t seem terribly confident of the prospects for addressing the too-big-to-fail problem quickly. “I am quite concerned that policymakers may double-down on previous decisions,” he says, and some ideas in the current environment “will waste valuable time and resources.”

Stern offers a three-point approach for reducing the size and scope of spillovers from a firm’s failure to prevent the need for intervention:

1) Early identification: Central banks and other bank-supervision agencies can conduct failure simulation exercises to identify problems around derivatives contracts, resolution regimes and overseas operations. One option would be to require too-big-to-fail firms to prepare documentation of their ability to enter the functional equivalent of a prepackaged bankruptcy.

2) Prompt corrective action: Bank supervisors would take actions against a bank as its capital falls below certain triggers. “Closing banks while they still have positive capital, or at most a small loss, can reduce spillovers in a fairly direct way,” he says.

3) Communication: Policymakers must communicate that creditors may be put at risk of loss.

The re-release of Stern’s book comes as the Obama administration, the Federal Reserve and Congress discuss a new resolution regime for major financial institutions (similar to the FDIC’s power over banks).

While Stern says society will be better off with it, he doubts that approach “will correct as much of the [too-big-to-fail] problem as some observers anticipate.” The FDIC resolution regime, he says, does not put creditors at banks at sufficient risk of facing losses. “A new regime will not, by itself, put an end to the support we have seen over the last 20 months.”