Bailout mindset likely to stay, Fed official says

OVERLAND PARK, Kan. - Kansas City Federal Reserve Bank President Thomas Hoenig warned Monday that landmark financial reforms may not end market perceptions that taxpayers will rescue the largest banks.

He also cautioned against speculative investments in housing.

Mr. Hoenig, testifying during a field hearing of the U.S. House of Representatives subcommittee on oversight and investigations, said larger banks that are perceived as "too big to fail" have a lower cost of capital and put smaller banks at a competitive disadvantage and threaten their business model.

The Dodd-Frank Wall Street Reform and Consumer Protection Act was intended to end Wall Street bailouts by giving regulators a mechanism to use to seize and shut down failing large institutions in much the same manner as the Federal Deposit Insurance Corp. can shut down smaller banks.

Mr. Hoenig said it was not yet clear whether the reform act would put big and small banks on an equal footing.

"That can only happen if markets are absolutely convinced that too big to fail has finally been ended, and only time will tell. It's an open question," he told the hearing in a Kansas City suburb.

Mr. Hoenig, the Fed's lone policy dissenter in recent months, did not address the U.S. central bank's outlook on the economy nor monetary policy matters.

Citing a gradual improvement in the economy, he voted against the Fed's decision this month to reinvest funds from maturing mortgage-backed securities into Treasury debt to help push down mortgage interest rates further.

He also told the House panel that housing was not suitable for speculative investments by consumers.

"If the American people are looking for the housing market to be their investment opportunity, I think they're making a mistake," Mr. Hoenig said. "I don't think the economics of the housing industry … is really designed for that. Right now, the facts are that we have an excess supply."

Mr. Hoenig said community banks had been tested by the "abnormally slow recovery" of the U.S. economy over the past two years, with the difficulties continuing.

"Commercial real estate, particularly land development loans, will be a drag on earnings for some quarters yet," he added.

Community banks are generally considered those with less than $10 billion in assets. They include all but about 83 of the 6,700 banks in the United States, Mr. Hoenig said.