Fed Says We Gotta Let Individual Banks Fail

A healthy economy “must be able to allow individual institutions to fail,” said Thomas Hoenig, Federal Reserve Bank of Kansas City president. He’s absolutely right. [NYT]


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  1. SacraBos says:

    While it’s no fun, he’s got a point. If the economy can’t stand to have an individual bank fail, then the economy isn’t diversified enough. I’d say this is an indication that maybe we need to watch these bank mergers a little more carefully.

    • corsec67 says:

      @SacraBos: I look at this comment differently:

      If banks aren’t allowed to fail, in that they get propped up by FDIC, then there are no consequences for failure.

      That means that any business plan that would lead to failure isn’t rejected as quickly.

      • @corsec67: Clarify for me, do you mean FDIC should not insure individual depositers, or that they should not assist in the finances of one bank buying another, failing bank, out?

        If you mean the former, why do you feel consumers should bear the brunt of the burden for letting bankers play with our money and failing?

        If you mean the latter, I’d vote for you.

        • corsec67 says:

          @valarmorghulis: I agree that having consumers bear the brunt of a bank failure would generally be a bad thing.

          I really don’t have any good ideas for a better way to do things, though.

          Maybe if banks had to pay for insurance with private insurance companies? Then they would get charged more for having “risky” investments.

          Or penalize the future earning of the board of directors if a bank fails?

  2. Xerloq says:

    Yay! Someone finally talking sense at the Fed. Now if we can just pass that wisdom on to the WCIA award winners and runner-ups…

    Yay free market!

  3. Trai_Dep says:

    Capitalism works best when a free market picks winners and losers. Even well-connected losers.

  4. whitefang2000 says:

    Let the banks fail. The FDIC is there for after the banks fail to insure the people who just lost all their savings. They are not there to save the banks.

  5. agnamus says:

    Bank failures have little importance to consumers. The FDIC insures the amount deposited in every account, and to be honest, very few folks have more than $100,000 in any given bank. So instead, I’ll rant about the banking industry:

    To say that a healthy economy “must be able to allow individual institutions to fail” can mean one of two things. The entirely palatable interpretation is that banks that are poorly managed should be culled. However, the more disturbing interpretation of Hoenig’s words is that banks should be a laboratory for managerial experiments, and the successes are allowed to live while the failures are allowed to die. This is the fate of all other industries in a capitalist market place–essentially, the strong survive.

    Banking is different than all other industries, though. With the FDIC insuring the majority of accounts, allowing managers to experiment is essentially handing someone a stack of poker chips and allowing them to gamble (in the form of investments with variable levels of risk–no the money you deposit doesn’t just sit there). There’s no way to solve the principle-agent problem here. That is to say, you are more prudent with your own money/possessions/etc. than you are with someone else’s.

    At least with investments (mutual funds, hedge funds, bonds, stocks, etc.) I have a choice of who I’ll allow to gamble with my money. With the FDIC insuring all banks, I have no choice about whether the federal government is taking my money, and I have no choice in who they’ll bail out. That should bother you just as much as it bothers me.

    Business failures usually come from inefficiency. Some fail because of dumb luck, but that’s not important here. It’s been well established for years that banking has little or no scope and scale inefficiency. Almost all inefficiencies come from management (“x-inefficiency” for you business nerds out there). Long story short, we can tell when a bank is poorly managed long before it fails. The fed should be stepping in much, much sooner than they currently do. Why they don’t is anyone’s guess (lobbying pressures perhaps).

    • Parapraxis says:


      If you have over $2200 in the bank, and no debts, you are richer than 50% of the population.

      (Of course, mortgages and the like factor heavily into the equation, but you get the gist)

      • MickeyMoo says:

        @Parapraxis: If that’s true (and I’ve no reason to doubt you – and no inclination to fact check) then it’s a sad statement about conspicuous consumerism in this country. That said, the FDIC hasn’t raised the rate in keeping with inflation :

        “The limit of $5,000 in 1934 was 12 years’ worth of per capita personal income at the time. The limit was last raised in 1980, to $100,000, which was then 10 years’ income. But because of inflation and economic growth, that limit is less than three years’ income today.”


        • agnamus says:

          1. As of 2010, the amount insured will be inflation-indexed.
          2. The limits are reactive, not proactive. The more and more influential people are screwed by bank collapses, the more likely congress is to intervene. You’ll know the banking system is in trouble when they do that. E.g. Glass-Steagall 1 (which set the $5000) limit was 3.5 years after Black Tuesday, and the 1980 increase was right on the cusp of the S&L crisis.

          Hilariously enough, Glass-Steagall 1 was enacted because banks were failing because they weren’t regulated enough. Bankers and brokers were one in the same, and an unacceptable amount of risk was inherent with any deposit. The S&L crisis came shortly after they were deregulated in the late 70’s. Glass-Steagall 2 was repealed in 99 by Clinton, and now we have banks failing and a sub-prime mortgage crisis.

          This isn’t to say that more regulation is a good thing. With any regulation that controls portfolio risk, econ 101 tells you that the returns on that portfolio will be less. Ultimately, this translates into lower rates on CD’s and savings accounts and more fees. Consumers are willing to stomach a little risk for a substantially greater expected return (ever been on etrade?). The question is what’s the right amount. If the fed allows banks to be too risky, collapses happen.

          N.B. although most people think that they’ll have a higher return on etrade, the returns there are generally less than savings accounts, and the median return is negative.

          • MickeyMoo says:

            @agnamus: Never tried e*Trade, read too many horror stories on Consumerist about them, went with a reputable discount flat rate brokerage instead. You certainly seem well versed on the subject – but having worked at an investment bank back in ’99 (and seen how the “sausage” is made) I’m going to have to respectfully disagree with your statement “This isn’t to say that more regulation is a good thing”

            S&L deregulation, USDA allowing food producers to self police, FDA allowing BigPharma to use the fast track loophole to push improperly tested drugs onto the market too soon, the chinese “poison train” of shady offshore subcontractors substituting adulterated ingredients in everything from toothpaste to toy paint, underfunded govt agencies essentially powerless to do anything, the examples are endless – I’m convinced regulation is a good thing.

          • mac-phisto says:

            @agnamus: This isn’t to say that more regulation is a good thing. With any regulation that controls portfolio risk, econ 101 tells you that the returns on that portfolio will be less. Ultimately, this translates into lower rates on CD’s and savings accounts and more fees.

            you know, the only thing about that – i’m not too young to remember 12% returns on deposit accounts & even more recently, 4% on even basic savings accounts. seems to me that while deregulation has resulted in more profits for banks, none of that has trickled down to depositors.

            regardless, i actually have a more sinister interpretation of hoenig’s words: if institutions can’t fail, we have no hope of ever having a healthy economy. & that makes sense. the game in banking today is: get big. get bigger. get as big as you possibly can & then you do whatever the f- you want b/c you’re too big to fail.

            that inhibits the natural cycle of capitalism. at some point, a company must fail so that new growth can rise from the ashes. this isn’t happening in banking today & so, we’re allowing institutions to get larger & larger until the inevitable happens – they fail or we bail.

            here’s some data on new banks in my state (conn.) –> [www.ct.gov]

            notice the negative trends in new bank charters since 1980. that’s disturbing to me – we’re trending towards a country with a handful of enormous banks & the virtual exinction of “hometown” banking institutions.

      • Parapraxis says:



        Here it is, in consumerist, of all places!

  6. tatsuke says:

    “If you mean the former, why do you feel consumers should bear the brunt of the burden for letting bankers play with our money and failing?”

    When you deposit your money in the bank, you are giving the bankers permission to play with your money. In return, you get (a miniscule amount of) interest. If that’s unacceptable, you’re more than welcome to put your paycheques under your matress.

  7. johnva says:

    Recessions are when the economy becomes more efficient by trimming the fat.

  8. Triborough says:

    Why do I have a feeling that Thomas Hoenig was really in Buenos Aires researching bank runs?

  9. sirellyn says:

    In the great depression thousands of small banks failed and the larger banks gobbled them up (and their customers.) It was established afterwards that part of the reason JP Morgan called back the options on their stock which caused the initial crash was to eliminate the competition.

    So a little ironic that the larger banks are “too big to fail” but the smaller ones. “Let them fail.”

    What do you suppose happens to the customer base when thousands of the little ones fail?

    This is why studying history is important.