Hoenig: Biggest Banks Are Worst Capitalized, Most Leveraged

FDIC vice-chairman Thomas Hoenig is getting a great deal of prominent coverage, both in the United States and Europe, of his April 2 research note on the FDIC website, challenging the Fed’s “stress test” passing of all the big Wall Street banks.

Although Hoenig has made this case before without such response, the situation around Glass-Steagall breakup of those Wall Street banks is heating up. Notable was the New York Times editorial of April 14, “Unsafe and Unsound Banks”; and a USA Today story April 15. The latter quotes Hoenig that the biggest SIFIs are the most leveraged and most at risk of failure and bailout.

Hoenig says the SIFI’s collective capital ratio average is actually only 4.9% (i.e., 21:1 leverage ratio, meaning each $100 of assets is backed by about $5 of capital and $95 of borrowed money), rather than the 12.8% (8:1 leverage) which the Fed claims from its “stress tests”. The difference, says Hoenig in the note, is their derivatives exposure, whose fair value FDIC estimates at $5 trillion by International Financial Reporting Standards. These standards, used internationally except on Wall Street, say that derivatives exposure should be counted as assets of the big banks which have no capital backup.

USA Today says Hoenig scoffed at the Fed’s assumption that the derivatives will virtually all “net out”, so they can be kept off the banks’ books entirely. In a crisis, they do not “net out,” as AIG and many others showed, because in a crisis, all the derivatives players are trying to cash out of derivatives at once.

Hoenig’s note was:

“The semi-annual update of the Global Capital Index, showing the capital ratios for Global Systemically Important Banks, released Thursday by FDIC Vice Chairman Hoenig.”

He delivered a version of the same verdict at today’s Levy Institute conference in Washington, speaking after Sen. Elizabeth Warren.