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Unjust Desserts

Harvey Rosenblum saw all kinds of financial collapses during a 40-year career with the Federal Reserve. His ideas on how to avoid the next one aren’t without some controversy.

Francisco Torralba, Ph.D., 04/10/2014

This article originally appeared in the April/May 2014 issue of Morningstar magazine.

In 2012, Harvey Rosenblum caused a stir in the typically stolid U.S. Federal Reserve banking system. From his position as the director of research for the Federal Reserve Bank of Dallas, Rosenblum wrote a controversial essay in the agency’s annual report that said the U.S.’s largest banks still posed a grave threat to the economy. Oligopolies, he called them. Rosenblum was trying to point out that just four years after the nation’s financial system almost collapsed, the same financial institutions at the heart of the downturn were still big and getting bigger.

Rosenblum retired last year after 40 years with the Federal Reserve. He now teaches at Southern Methodist University. But he isn’t going quietly into retirement. Rosenblum is still vocal about steps the United States and the world must take to avoid another financial calamity. His ideas will find their way into a forthcoming book. I sat down with Rosenblum on Feb. 20 at the Morningstar Ibbotson Conference in Phoenix. The conversation has been edited for clarity and length.

Francisco Torralba: You’ve done a lot of work with Dallas Federal Reserve president Richard Fisher about the too-big-to-fail problem. Let’s start by defining the problem. What is too-big-to-fail with regard to U.S. banks?

Harvey Rosenblum: The problem is that the public believes, especially after the experience of the past few years, that if a large bank gets into trouble, somehow not only the bank, but its creditors, will get government assistance. In the case of some of the largest banks in 2008 and 2009, it was truly extraordinary government assistance that came to the fore to protect the bank, its shareholders to some extent, and creditors to an enormous extent.

Assets continue to pile up in the large banks at the expense of assets going to more efficient, smaller banks that do most of the lending in our economy. The largest banks in recent years have diversified away from lending and have become casinos operating extensively in the derivatives markets, investment banking, and a number of other things. “Casinos” is too harsh a word, perhaps. But they are risk-taking traders. Their lending to the economy is a much smaller proportion of their asset base than it’s ever been before. 

I have nothing against them doing those businesses. What bothers me is when they engage in those businesses with the belief that if they get into trouble somehow the public safety net is there to protect them. 

The ‘Too-Big-to-Fail’ Subsidy
Torralba: From reading the papers and speeches that you and Fisher have given, I gleaned that there are two problems here with too-big-to-fail. One is this implicit guarantee leads to excessive risk taking and concentration of risk. The other problem is that it’s unfair to the smaller banks, which don’t have the same implicit guarantee and, therefore, operate at a disadvantage. Would you say that that’s a fair statement?

Francisco Torralba is an Economist for Morningstar Investment Management.

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