Why a Fed official is targeting big banks

He oversaw Washington’s bailout of the nation’s biggest banks. He campaigned for governor of California. He was one of People magazine’s “sexiest men alive.”

Now, Neel Kashkari is president of the Federal Reserve Bank of Minneapolis. This month, he proposed a radical rethinking of the U. S. f inancial system. In a speech at the Brookings Institution, he argued that big banks remain too big to fail and began a campaign to solicit solutions. Among his ideas: Break up the banks, force them to hold as much capital as utilities or levy a tax on leverage.

Kashkari sat down to discuss those ideas. This interview has been edited for length and clarity.

You argue that Dodd- Frank did not go far enough. Big banks still pose a risk to the economy. How safe do you feel the financial system is right now?

The financial system is much safer than it was before we had the financial crisis. Increased capital in the banks is unquestionably a good thing. Deeper liquidity, a good thing.

We have to make changes while markets are stable, while the economy is stable, so we are ready when the next wave comes. I’m arguing that now is the time we take those steps we need to take, because in my judgment the steps we’ve taken do not go far enough.

If you look around the global economy, there’s a lot of uncertainty. There are people who are concerned about China’s slowdown and whether it’s going to be a hard or soft landing. All of those are out there, but it’s very hard to see crises coming.

Nobody was omniscient enough to call $ 100 oil or $ 150 oil a bubble. I’m not saying that it was a bubble; I think it’s supply- and-demand forces. But certainly nobody forecast it going down to $ 30. That’s just an example of an exogenous shock. Everybody’s eyes were open. What else don’t we see coming?

On too- big- to- fail, it struck me that maybe this issue of whether they’re big or broken up is a sideshow, and the real issue is more a Glass- Steagall question. ( The Glass- Steagall Act, which separated commercial and investment banking activities, was overturned in 1999.) Why isn’t that the point as opposed to what size you make the bank?

That’s a little bit like the utility model, where you said, you know what, banks can grow in size, but because they serve this important role in the economy, we’re going to put so much capital in them that they virtually can’t fail. And then you let the rest of the economy, the rest of the financial system, do what they do as long as they don’t get so big that they’re destabilizing. I have some sympathy with that view. I’m not prejudging whether that’s the correct or incorrect answer.

But to Glass- Steagall specifically, it isn’t clear to me that just keeping investment banking separated from depository lending is necessarily by itself a solution. If we go back to the root causes of ’ 08, we had a nationwide delusion that home prices only go up. I participated in that delusion: I bought a house in California in 2005. Traditional banks made a lot of bad loans based on the premise that if home prices keep going up, these loans are going to be OK. And so Glass-Steagall wouldn’t have prevented that.

The bank stress tests look at how these banks would do in bad economies. You seem to be saying you don’t believe it.

To really be strong enough against a shock we haven’t thought of, we would either need much, much higher capital requirements — the banks are already pushing back hard against the capital surcharges — or we need to look at much stronger or more intense stress scenarios.

I’m colored by my experience in ’ 08. A lot of these tools are eminently sensible and can work if conditions are fairly straightforward. But if you’re in a crisis scenario, all bets are off.