(Bloomberg Opinion) -- The U.S. Federal Reserve has made full use of its emergency arsenal to keep the financial system operating amid the coronavirus crisis. Its extraordinary efforts have helped keep credit flowing to households and businesses in desperate need.
Yet even as the Fed spares no effort, the largest U.S. banks are failing to take their own emergency measures. Most notably, they are continuing to pay dividends, depleting the loss-absorbing capital they need to weather the crisis. If they lack the will to act prudently, Congress should consider a better solution, and soon.
To be fair, the eight largest U.S. banks have come together to pause share buybacks, another sort of capital-eroding payment to shareholders. But if these banks keep paying dividends at 2019 levels, they will still redirect more than $40 billion to shareholders this year alone. If they resume buybacks in the second half of this year, that will be another $50 billion. And if other systemically important U.S. banks maintain disbursements as planned, that’s $40 billion more. All told, the largest banks will shed $130 in capital precisely at the moment when they need it most.
Neither the banks nor their regulators have given any indication that a mandatory payment halt is on the horizon. In this regard, the U.S. is an outlier: the European Central Bank and the Bank of England have already pressed financial institutions to stop making planned disbursements.
These are not new mistakes. Amid the last financial crisis in 2008, Lehman Brothers famously increased its dividend the same year it filed for bankruptcy. Large financial institutions such as Citigroup and Wells Fargo kept paying dividends long after receiving taxpayer funds. Then, as now, institutions worried that halting disbursements would make them look weaker than their peers, even though it would have been better for the system as a whole.
Regulators have clear legal authority to overcome this collective action problem. But as the current crisis highlights, authority alone is insufficient. Officials are invariably reluctant to rock the boat in turbulent times. Some, such as Cleveland Fed President Loretta Mester, suggest that the Fed wait for this year’s stress test results before making any decisions on disbursements. But even if the tests (which are outdated, subjecting old balance sheets to scenarios more optimistic than reality) could be adjusted to reflect the current moment, the results won’t be available for months. Meanwhile, capital will keep flowing out of the system.
What to do? Make prudence automatic. For example, payouts to shareholders of systemically important banks could be halted whenever the Fed invokes its powers -- under Section 13(3) of the Federal Reserve Act – to extend credit in “unusual and exigent” circumstances. The ban would stay in force at least as long as the central bank kept making emergency loans, longer if deemed appropriate. This would free Fed officials from difficult choices, and eliminate stigma by applying to all relevant institutions simultaneously.
As with all reforms, there will be a risk of unintended consequences. Tying shareholder payouts to emergency measures might make Fed officials reluctant to use the latter in times of distress, or might unduly burden banks at times when the measures are actually needed elsewhere in the financial system. This could be addressed by halting payments only when banks are eligible for 13(3) support, or by creating an override mechanism requiring the joint agreement of Fed and Treasury officials. Another option would be to use a trigger other than the 13(3) powers. Market measures of financial health, such as the performance of bank stocks or market-based capital ratios, proved highly predictive of failure in 2008. For many large banks, they are now back down to levels not seen since then.
Legislators have called on the Fed to halt bank dividends. But this isn’t enough. When it’s obvious to the central bank that circumstances are “unusual and exigent,” when trillions of taxpayer dollars are on the line, banks and their shareholders should be shouldering their share of the burden. Time and again, large financial institutions have proven reluctant to safeguard themselves. Congress should act to make it obligatory.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Natasha Sarin is an assistant professor at the University of Pennsylvania Law School and an assistant professor of finance at the Wharton School.
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