Inside the 2025 Bank Reg U-Turn
Karen Petrou is again featured on IntraFi’s podcast, Banking with Interest, hosted by Rob Blackwell. It’s a wide, wide-ranging discussion of issues from deposit-insurance reform to sharp reductions in the Fed’s portfolio, whether stablecoins really have a use case, and what’s next from the federal banking agencies.
Listen here.…
In a speech last week, Secretary Bessent described Treasury obligations as “not only the bedrock of the global financial system, but also the American dream.” So they are, but they are also a huge source of profit to basis-trading hedge funds happily evading U.S. taxes in the Cayman Islands. Should the Fed grow its already-gargantuan portfolio at still more taxpayer risk and expense just to keep the good times rolling? Are there no better ways to ensure Treasury-market stability without a Fed portfolio so large that, as Secretary Bessent has also said, it makes America ever less equal? There are indeed better ways and the Fed should deploy them, not just comfort the morally hazardous with still another backstop.
An October Federal Reserve study finds that a longstanding source of FRB systemic-risk worries —basis trading hedge funds — is dramatically under-counted in conventional Treasury-market data sources. Cayman Island-domiciled hedge funds are now, the Fed data show, the largest foreign holders of Treasuries with $1.85 trillion as of the end of 2024 – a trillion-dollar run-up in just two years. Their holdings now eclipse those of each of China, Japan, and the U.K. who are otherwise the largest foreign holders. Only the Federal Reserve holds more Treasury obligations than all these hedge funds in the tax-free sun.
At the same time, short-term rates continue to show significant signs of stress surely worsened by the fact that leveraged basis-traders borrow repos without posting lending to net out most of the risk. …
In remarks last week, Secretary Bessent drew attention to a new OCC and FDIC proposal that, among other things, defines what will be considered “unsafe” and “unsound” when it comes to bank examination and enforcement. As Mr. Bessent said, “While simply defining a term might seem like a small thing, …, a clear focus on material financial risk will put an end to this nonsense.” By which he meant the egregious supervisory lapses that led to four costly bank failures in 2023. He’s right, but the banking agencies must also match these new words with far faster, tougher, and transparent supervisory deeds.
There’s no question that supervisory policy has long forced banks to think at least as much about papering decisions as making them. This is a particular problem for community banks without teams of compliance specialists, adding all too much cost to the technology and product innovations essential to banks that aren’t just safe, but also sound competitors that serve their communities. Much in the post-2008 rulebook needs a rewrite and almost everything proposed after the 2023 crash is badly designed.
But ripping out too many pages in righteous rage could spark yet another of the downward spirals in lax rules and irresponsible banking that occur every other decade or so. I thus worry about a few aspects of this new proposal.
For example, the proposal bars supervisory sanction unless or until a material loss is foreseeable or has actually occurred. Violations of banking or consumer law cannot …
As we noted last week, a new study finds that stablecoins and other crypto payments use declined from 2022 to 2024 by about a third, now including less than two percent of U.S. households. Further, these are disproportionately unbanked, with the only bit of growth in payment-stablecoin use coming from households with poor or very poor credit scores. Payee choice was the most important driver of decisions to use a payment stablecoin. These jarring facts brings the trillions-of-trillions of dollars stablecoin dreamers back to earth with a hard thump. They might still prevail, but only if banks don’t quickly counter with potent products and nonbanks also get the rules they want and the payees they need to redefine their problematic stablecoin value proposition.
One critical battle is already being waged. Banks are fighting hard to prevent indirect payment of incentives that advantage stablecoin holders and thus undermine transaction-account alternatives. This question is among the most important on which Treasury now seeks comment before it quickly starts writing rules. The Senate Banking Committee might also revise the GENIUS Act at cost of bankers.
Despite the plethora of questions in Treasury’s recent request, another important issue is omitted: who may own a nonbank stablecoin issuer. The Act as is contains a prohibition on ownership by publicly-traded nonfinancial companies, but Treasury can waive this ban if it and other regulators reach several findings that won’t be too hard to find if Treasury wants them unearthed. Pending changes in law and rule could also …
The Fed’s New “Gain-of-Function” Monetary Policy
By Scott Bessent
Overuse of nonstandard policies, mission creep, and institutional bloat are threatening the central bank’s monetary independence….In her book Engine of Inequality: The Fed and the Future of Wealth in America (2021), progressive financial policy expert Karen Petrou documents how the Fed’s pursuit of a “wealth effect” to stimulate the economy backfired. “Unprecedented inequality,” wrote Petrou, “is clear proof that the wealth effect is all too effective for the wealthy, but an accelerant to economic hardship for everyone else.” Economists’ focus on the supposed benefits of the wealth effect is particularly odd given that the Fed’s asset purchases act more powerfully on the discount rate at which assets are valued than the stream of cash flows that underpins the asset’s price. Asset owners are less likely to bring forward consumption as a result of changes in the discount rate than income growth, and to the extent that they do increase consumption, the effects may reverse once discount rates are normalized. In Petrou’s view, the exacerbation of income and wealth inequality is a function of the distribution of assets in the United States—which the Fed should take as a given. Only the very wealthiest individuals own financial assets that are most directly impacted by the Fed’s large-scale asset purchases. Moving down the spectrum, a substantial portion of the middle of the income distribution has exposure to home equity, but this asset is less sensitive to the Fed’s financial market machinations. The …
The Fed’s ‘Gain of Function’ Monetary Policy
By Scott Bessent
As we saw during the Covid pandemic, lab-created experiments can wreak havoc when they escape their confines. Once released, they can’t easily be put back. The “extraordinary” monetary-policy tools unleashed after the 2008 financial crisis have similarly transformed the Federal Reserve’s policy regime, with unpredictable consequences. The Fed’s new operating model is effectively a gain-of-function monetary policy experiment. Overuse of nonstandard policies, mission creep and institutional bloat threaten the central bank’s independence. The Fed must change course. Its standard tool kit has become too complex to manage, with uncertain theoretical underpinnings. Simple and measurable tools, aimed at a narrow mandate, are the clearest way to deliver better outcomes and safeguard central-bank independence over time….By failing to deliver on its inflation mandate, the Fed allowed class and generational disparities to widen. Its pursuit of a wealth effect to stimulate growth backfired. “Unprecedented inequality is clear proof that the wealth effect is all too effective for the wealthy, but an accelerant to economic hardship for everyone else,” financial analyst Karen Petrou wrote in her book “Engine of Inequality” (2021). The Fed’s growing footprint has profound implications for independence. By extending its remit into areas traditionally reserved for fiscal authorities, the Fed has blurred the lines between monetary and fiscal policy.
Trump wants to shake up the Fed. Stephen Miran has a playbook
By Sam Sutton
White House economic adviser Stephen Miran is one of Donald Trump’s chief strategists for scaling back the Federal Reserve’s autonomy. The president is giving him a shot at disrupting the central bank from the inside. The Harvard-trained economist, tapped by Trump for a Fed board seat, has proposed measures that would allow the president to fire Fed governors at will. He wants to end the inflation targeting that anchors expectations for prices and has slammed the “wildly inappropriate” purchases of Treasury debt during economic expansions….“Miran would have little difficulty reflecting the president’s views,” said Karen Petrou, the managing partner of Federal Financial Analytics. The proposals he has crafted would create “a far more political central bank.” Critics of Trump’s moves are concerned that a more political Fed would make interest rate decisions based on near-term considerations to aid the economy rather than in the long-term interest of price stability….“There’s a lot that needs to be shaken up,” Petrou said. In that regard, “Miran is certainly the guy to do it.”
https://www.politico.com/news/2025/08/29/trump-fed-shake-up-stephen-miran-00534615
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Trump, Pulte weaponizing housing finance for political ends, experts say
By Andrea Riquire
…“The president has just made us a higher-risk country”
Host David Brancaccio talks with Karen Petrou at Federal Financial Analytics after President Donald Trump moved to fire Federal Reserve Governor Lisa Cook last evening. That’s Petrou’s conclusion “The president has just made us a higher-risk country”
https://www.marketplace.org/episode/2025/08/26/the-president-has-just-made-us-a-higherrisk-country…