FDIC Director Thomas M. Hoenig: Financial Stability through Properly Aligned Incentives

FDIC board member Thomas Hoenig delivered a speech ("Financial Stability Through Properly Aligned Incentives") before the Exchequer Club in Washington, D.C., arguing that commercial banks should once again be prohibited from engaging in higher risk activities such as investment banking. Hoenig's speech cites the period Glass-Steagall was in effect as having been a "period of relative stability . . . and strong growth of the economy," and goes on to state that the repeal of Glass-Steagall changed the incentive structure in banking and finance to encourage greater risk-taking and leverage within the financial system.

Hoenig's essential argument is that incentives -- not regulation -- are the primary driver of behavior, and that therefore, more regulation is not the solution. He contends that the U.S. financial system, both before and after the crisis, has been weighed down by "misaligned incentives" in the wake of Glass-Steagall's repeal, and proposes that the public safety nets of deposit insurance and the discount window should be returned to their intended purpose. To that end, Hoenig proposes that commercial banks should again be restricted from engaging in higher risk activities such as trading, creating derivatives, or other broker-dealer activities. In the absence of such a change, the "fundamental cause of the problem" will not have been fixed, and despite any new regulations, the "behavior and practices leading to this crisis will soon reemerge."

View speech here (links externally to FDIC website).