KANSAS CITY, Mo. — Thomas Hoenig, the president of the Federal Reserve Bank of Kansas City, one of the most outspoken members of the Federal Open Market Committee, has never been shy when it comes to his opinion.

As his 20-year tenure comes to a close on Oct. 1, Hoenig sat down with American Banker to talk about a range of topics, including the missed opportunity to eliminate 'too big to fail' in Dodd-Frank, his duty to be forthright as the longest serving policy maker, and what his future plans might be — including the prospect of moving to Washington. This is an abridged edited version of the interview with Hoenig.

Q: You've been a strong critic of Dodd-Frank, how do you think the law has fallen short and how do we correct it?

HOENIG: The Dodd-Frank bill now defines what a systemically important financial institution is, which makes it now a kind of broad notice that these are the institutions that are 'too big to fail.' That means we will further concentrate our financial system to these powerful few companies, and therefore make it even more fragile in the sense of financial vulnerability to the taxpayer. I don't think that's healthy.

Q: Banks seem very concerned about how much capital they are going to have to raise as a result of Dodd-Frank and Basel III.

HOENIG: They're concerned about their return on equity, and I'm concerned about the safety of the banking system and the American depositor and taxpayer. All the safety net has done is allowed them to leverage up to their advantage on the backs of the American taxpayer. I have a hard time as a person, who is more concerned about the safety of the system and the taxpayer, to worry about their position.

Q: You've said the only solution is to break up the banks and strengthen the 'Volcker Rule.' Would that undo the codification of 'too big to fail'?

HOENIG: You can mitigate. You can make it less likely that they are 'too big to fail' because you separate out these horribly, complex instruments from the institution, therefore you can address the risk in those institutions more directly.

Q: Did Dodd-Frank make the financial system any safer?

HOENIG: I don't see it as more safe. I see it as less safe. My question is, How is it more safe? What's now making it more safe? Supervision? We had supervision. Capital? We had capital. Resolution? We had resolution. What's different about this? Complexity, less complexity? No. Better capital standards? Marginally, temporarily. What's better about it? You have to be able to tell someone what's better about it.

Q: You have said before it's inevitable we will have another crisis. What do you see as the next pockets of systemic risk?

HOENIG: You've got people who are in high regulatory positions today. You have legislators that are in key positions today talking about competitive disadvantage with other parts of the world. Therefore, we have to ease up on our rules, because we may be at a disadvantage. These institutions might go overseas. I only wish we worried about manufacturing the way we do with these financial institutions. We are already backing off our standards.

Q: Given what we know and what you've been through during the last financial crisis, will regulators be able to catch the next crisis, whether its five, 10, 15 years down the road?

HOENIG: It would be the first time in history. I would be very, very impressed.

Q: What's the problem?

HOENIG: Look it, I've got a crystal ball on my desk. It doesn't work. I can't predict the future. I can say I see the risk. I see the conditions in place. Zero interest rates, a very extensive easing of monetary policy, I can see that and those create conditions for credit bubbles. Now, it doesn't mean you are going to have a credit bubble, but they create the conditions. But everyone says, 'I don't see it, so therefore don't interfere with it.' Then the crash comes. No one wants to believe there is a systemic problem, so therefore there is no systemic problem until there is, and that's human nature. You can put all the systemic risk commissions in the world in place, they're human beings.

Q: Given that, what should regulators be focused on?

HOENIG: What regulators should do is regulate, supervise. I'm sorry; I'm not a strong stress test guy. I'm an examiner guy. I want to go in and look at the books. I want to test their systems. I will tell you on Basel III, Basel II you cannot rely on the institution to tell you the truth. Because when things get tough, when the market starts to fall, they can't because it puts them out of business. That's why you have examiners. You have to go in and say, 'I want to crack the books. I want to follow this loan. I want to verify the collateral, the quality of the collateral. I want to test it.'

Q: Do you think regulators had their hands off the wheel when it came to supervision ahead of the crisis?

HOENIG: I think they were operating under the misperception that they could judge risk by looking at process and procedures from a distance rather than hands on.

Q: Does Dodd-Frank put the pressure on regulators to provide tougher supervision?

HOENIG: That's the irony. Yes, it does. Yet that's one of the backlashes. Bankers are saying, and legislators are saying, over and over again, that the examiners … over reacted. They're too tough. There's no forbearance. There's no understanding. There in lies part of the issue. If the loan is a bad loan, it is a bad loan. I can't make it good for you. What they really want is time to see if they'll turn around, and I understand that. But when things go bad, then the examiner, the supervisor is chastised for not being tough enough as we were for the time leading up to the crisis. As a mentor of mine said, 'You're in a business where there are no successes, there are only failures.'

Q: Who said that?

HOENIG: Bill Taylor. [former chairman of the Federal Deposit Insurance Corp. and general counsel of the Federal Reserve Board]

Q: What will it mean for the future of the banking landscape if the economy does not recover as robustly as we hope?

HOENIG: The greatest threat to the banking system is concentration in banking in this country. It's not the economy itself; it's the fact that we have fewer and fewer banks allocating resources in this country. Even as late as the 1980s, you had as many as 14,000 banks in every community. Now, we have 6,500 and it's shrinking.

Q: On the dividend issue, banks appear to be in a tough spot in wanting to make capital distributions to demonstrate to their market signs of health.

HOENIG: Paying out your earnings is a sign of health? It's a subterfuge. Strong banks can pay dividends. Strong companies pay dividends. If they're strong and have capital, fine. But 4% capital is not strong. 5% capital is not strong. 6% capital is not strong. 8% is marginal in my opinion based on history. So, why should they pay dividends until they get their capital where it should be? I'm the taxpayer; I don't want to pick up their mistakes again.

Q: Does the Fed's stress test impact the market, and perhaps create some volatility?

HOENIG: The only way it would create any volatility is if the companies can't pass the stress test. If they can pass it, what's the problem? They should be celebrating.

Q: How far has the Fed come in providing transparency to the market?

HOENIG: I think we have gotten better, and I think we need to get better still. But, and I think the best way to do that, and this is because I have a bias, is to allow dissent among members of the committee. I think that would actually bring confidence to the market. The Supreme Court has 5-4 decisions all the time. It's healthy. We should have the same thing. I think it would inform the pubic as to what the issues are and what the different views are.

Q: You've been depicted as key dissenter on the Federal Open Market Committee, having dissented eight times. Are you comfortable with that characterization that's been now associated with your role as Fed president?

HOENIG: That's what I'm there for. I'm not there to validate someone else. I'm there to vote my conscience based on the facts that I know and the experience, which I might say, is extensive. So why shouldn't I vote my views? My duty is to the country, my duty is to the people, and I'm going to carry out my duty.

Q: Are community banks in for a bumpy ride as a result of Dodd-Frank despite lawmakers' attempts to preserve them?

HOENIG: Yes, they are. It's unavoidable. It's a complicated piece of legislation with many, many, many parts. It's a training challenge for our examiners; therefore it will be challenge for the bankers. The community banks don't have a cast of lawyers. They have to deal with this, and they have to get through it. It will encourage exit from the industry, and therefore encourage further concentration of resources.


Q: You have some strong points of view on interchange. Tell me more about that.

HOENIG: We've gone to a regulated price, which is absolutely not going to work. Because whenever you regulate prices you game it. Who knows what the right price is? That's beyond our skills. That's what markets are all about. That's why we believe in markets in this country, and yet we are abandoning the market. The alternative is for the Federal Reserve structure — not the Board of Governors, but the 12 banks — to continue to be part of the payments system as they are in checks. Instead of requiring mandatory price controls, you say debit cards have to be decoupled so you can pick any exchange that is a merchant can go across Visa, can go across MasterCard, or can go across the ACH, or some other. The Fed, like it does with checks, has to recover its costs and return on equity that's comparable to the industry's moving average

Q: Does the fault lie with Congress in the way it drafted the legislation?

HOENIG: I think it was everyone's fault. I think it was the industry's fault. I think it was legislator's fault. I think it was the Federal Reserve's fault.

Q: Do you think there's a chance to work on a proposal that you've suggested?

HOENIG: There's always a chance. There's always an opportunity. But that would be up to the Congress of the United States. Right now, the law is the law, and we have to follow it.

Q: Any plans to go to Washington?

HOENIG: If the right job is offered.

Q: There happen to be a few openings.

HOENIG: There are quite a few openings, but I'm not sure. I made it very clear I'm willing to serve. I have quite a lot of experience I can offer.

Q: Do you think you'll write a book?

HOENIG: People have asked me that. We'll see.

Q: That's a yes.

HOENIG: No, no, no I don't know if it would serve a purpose, and I'm trying to figure out who would read it.

Q: What are you going to miss the most?

HOENIG: Arguing with people. [Laughs] For all of its change and all of its flaws; it's an institution of integrity. I have strong differences with, but it's still the best institution, and I've enjoyed every minute of it and I hope I've contributed to it. I've never held back with those I disagree with.