FDIC VP Opposes Easing Inter-Affiliate Margin Requirement (with Lofchie Comment)

FDIC Vice President Thomas Hoenig cautioned lawmakers about the risks involved in not requiring firms to post collateral in trades with their own affiliates.

In a letter to the Chair and Ranking Committee Member of the House Appropriations Committee, the FDIC Vice President stressed that requiring the inter-affiliate margin (i) minimizes the amount of risk that can be brought into the taxpayer-funded safety net, (ii) reduces excess leverage at the largest banks, (iii) ensures that liquidity will continue to be available to farmers and ranchers in periods of economic stress and (iv) makes the resolution of large financial firms easier.

Hoenig also warned lawmakers that "without margin exchanged for these trades, affiliates often enter into uncleared swaps transactions with the banks," and that "these affiliates can often operate with less capital and liquidity reserves than the market would otherwise require, as market participants treat these affiliates as if they were an extension of the bank."

Lofchie Comment: There is no clear answer to the question of whether financial affiliates should be required to post margin to each other on uncleared swaps. In arguing for that requirement, Mr. Hoenig makes some good points, but is less clear in certain areas. For example, Mr. Hoenig states that "requiring JP Morgan's affiliate operating in London to post margin to JP Morgan's US bank, would have helped keep the London Whale trading losses outside of the federally-insured bank." However, Mr. Hoenig does not identify the losses that he believes were borne by the bank as a result of the London Whale's trading and that would have been eliminated by taking margin. Were there any such losses? Similarly, it is not clear why Mr. Hoenig believes that increasing capital requirements will "ensure that liquidity will continue to be available to farmers and ranchers in times of economic stress." Ordinarily, increasing capital requirements decreases liquidity. That might very well be an acceptable trade-off, but the more powerful argument would be to acknowledge the trade-off and defend its value instead of asserting that higher capital requirements would somehow result in more liquidity.

See: Mr. Hoenig's Letter.