At Minneapolis Fed, economists see risks in big banks but reject breakup strategy

At the end of a daylong discussion on how the largest American banks might be allowed to fail in an orderly way if they ever face a crisis like the one in 2008, Neel Kashkari said he was reminded of "Star Wars."

He called the new rules governing bank resolution a "very clever, delicate mousetrap" and then likened them to the plan the Rebels in the "Star Wars" stories came up with for destroying the Death Star. A single fighter needed to fly under the radar, through a passageway along the starship's surface, and then shoot a torpedo down a tiny service shaft.

"It worked, because Luke Skywalker had the Force," Kashkari said. "Maybe 20 years from now, the FDIC and the Fed can invoke Obi-Wan Kenobi and the Force will make all these bells and whistles line up just perfectly, and we won't need the taxpayers to step in. Call me a skeptic."

Another group of heavy economic hitters — including former Fed Chairman Ben Bernanke — made the trip to Minneapolis for the second symposium Monday on ending "too big to fail," the problem that some U.S. banks are so important to the economy that taxpayers will need to save them if trouble surfaces. Kashkari, the new president of the Minneapolis Fed, is leading an attention-getting, yearlong initiative to find solutions to banking industry risk.

Breaking up the big banks received cool treatment at the forum, including from Bernanke. But few in attendance thought the large banks are past being bailed out and one speaker rejected the idea that taxpayer bailouts can ever be ruled out.

Referring to Citigroup, the only one of the largest banks not to have its plan for an orderly bankruptcy outright rejected this spring by regulators, J. Christopher Flowers, a bank investor, said he cannot imagine the bank being wound down in a crisis without taxpayers guaranteeing the investments of the bank's creditors.

"It's too big, it's just not going to work," Flowers said. "So we should try to make it safer, and less likely, but not say it's never going to happen."

Others felt more urgency to put an end to taxpayer bailouts. John Bovenzi, a former FDIC regulator and now a consultant, said progress is being made. Many banks are starting to restructure, increasing their capital and reducing their complexity. Some are shrinking in response to new rules that they have a plan — known as a living will — on how they would wind down in a crisis.

"Granted, the living will process is very much a work in progress, but the pressure for credibility and pace of change is accelerating," Bovenzi said.

Bernanke spoke during an afternoon session and argued against breaking up the big banks.

"Size is not the only relevant attribute of banks," he said.

Progress has been made to reducing the need for taxpayer bailouts in the future, he added, but the incentives for banks still need to change.

"In order to end too big to fail, there will have to be major structural changes in the financial industry over time," Bernanke said. "The problem is that we really don't know what those changes are going to need to be."

If regulators and the industry persist in looking for the right structural changes, Bernanke believes they may be successful.

It was the Byzantine discussion of the specifics of bank resolution — how a systemically important bank would be taken into bankruptcy without either destroying the economy or requiring a taxpayer bailout — that elicited Kashkari's Star Wars analogy.

Monitoring a bank for weakness as a financial crisis plays out is very difficult, he said, given how little government officials know about the bank's assets. Monitoring several banks at once, Kashkari said, is obviously more difficult, a truth that was seared into him during the financial crisis.

"In a time of major crisis," Kashkari said, "this kind of complexity terrifies me."

Adam Belz • 612-673-4405 Twitter: @adambelz