Eliza Allen – Page 3 – Federal Financial Analytics

22 04, 2024

FedFin on: Fed Systemic-Risk Assessment: Some Worries, No Troubles

Eliza Allen2024-04-23T16:37:21-04:00April 22nd, 2024|The Vault|

The latest Federal Reserve financial-stability assessment continues the Fed’s practice of detailing vulnerabilities without drawing bottom-line conclusions; the Board once did so, but ceased this practice after opining that the financial system’s risk was “moderate” shortly before the 2020 crash. The Board’s report now also says that it assesses vulnerabilities, not the likelihood of near-term shock. Survey respondents do make this assessment, with this report showing a striking increase in concerns about policy uncertainty in light of continuing inflation and the higher-for-longer rate outlook…

The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…

5 04, 2024

Marketplace, Friday, April 5, 2024

Eliza Allen2024-04-05T15:37:25-04:00April 5th, 2024|Press Clips|

When is strong hiring too strong?

by David Brancaccio

Hiring in the month that just ended was quite a bit stronger than expected, with more than 300,000 jobs added to payrolls and the unemployment rate falling slightly to 3.8%. That’s continuing the Fed’s interest rate predicament. We’ll discuss with Karen Petrou, co-founder and managing partner at Federal Financial Analytics.

A lot of businesses want to use AI to cut staff

…

1 04, 2024

Karen Petrou: The Frightening Similarity Between Key Bridge and Bank Stress Tests

Eliza Allen2024-04-12T09:41:28-04:00April 1st, 2024|The Vault|

On Friday, the Washington Post reported that Key Bridge passed all its stress tests before it fell into the harbor. These were well-established protocols looking at structural resilience – acceptable, if not awesome – and, after 9/11, also at terrorist attack. That a giant container ship might plow into the bridge was not contemplated even though this has happened before in the U.S. and not that long ago. Which brings me to bank stress-testing and how unlikely it is to matter under actual, acute stress because the current U.S. methodology correlates risk across big banks in ways that can make bad a lot worse. Even more troubling, tests still don’t look over the banking parapet.

To be sure, the Fed’s semi-annual financial-stability reports (see Client Report SYSTEMIC97) muse about risks that lurk outside the largest banks, and FSOC dutifully catalogs nonbank risk each and every year in a copious annual report (see Client Report FSOC29). Last year, FSOC also said a lot about what might someday be done to address it via systemic designation (see FSM Report SIFI36). But what’s being done, not just said, about nonbank risk even as inter-connections become ever more entwined? Not much in the U.S. even though other national regulators are taking meaningful steps first to know where it lies and then to curtail it.

For example, the Bank of England and Australia’s Prudential Regulatory Authority are quickly moving past bank-centric stress testing, with Australia importantly looking not just within the financial …

25 03, 2024

Karen Petrou: How the FDIC Fails and Why It Matters So Much

Eliza Allen2024-03-25T11:45:45-04:00March 25th, 2024|The Vault|

Last January, we sent a forecast of likely regulatory action and what I called a “philosophical reflection” on the contradiction between the sum total of rules premised on unstoppable taxpayer rescues and U.S. policy that no bank be too big to fail. Much in our forecast is now coming into public view due to Chair Powell and Vice Chair Barr; more on that to come, but these rules like the proposals are still premised on big-bank blow-outs. I thus turn here from the philosophical to the pragmatic when it comes to bank resolution, picking up on a stunning admission in the FDIC’s proposed merger policy to ponder what’s really next for U.S. banks regardless of what any of the agencies say will result from all the new rules.

Let me quote at some length from the FDIC’s proposed merger policy:

“In particular, the failure of a large IDI could present greater challenges to the FDIC’s resolution and receivership functions, and could present a broader financial stability threat. For various reasons, including their size, sources of funding, and other organizational complexities, the resolution of large IDIs can present significant risk to the Deposit Insurance Fund (DIF), as well as material operational risk for the FDIC. In addition, as a practical matter, the size of an IDI may limit the resolution options available to the FDIC in the event of failure.”

In short, the FDIC wants to block most big-bank mergers because it can’t ensure orderly resolution of a large insured depository …

4 03, 2024

Karen Petrou: The Madness of a Model and its Unfounded Policy Conclusion

Eliza Allen2024-03-04T11:50:02-05:00March 4th, 2024|The Vault|

As the pending U.S. capital rules head into their own end-game, there is finally a good deal of talk about an issue long neglected in both public discourse and banking-agency thinking: the extent to which higher bank capital rules accelerate credit-market migration. Simple assertions that more capital means less credit are, as I’ve noted before, simplistic. One must consider how banks reallocate credit exposures to optimize capital impact and, still more importantly, how the credit obligations banks decide to leave behind take a hike. Now comes a new paper the Financial Times touts concluding that, thanks to shadow banks, “we can jack up capital requirements more.” Maybe, but not judging by this study’s design. Even with considerable charity, it can be given no better than the “very creative” grade which kind primary-school teachers accord nice tries.

The paper in question is by Bank of International Settlements staff. It looks empirically – or so it says – at what it calls the U.S. banking sector’s share since the 1960s of what it lugubriously calls “informationally-sensitive loans.” It documents a lot of numbers said to demonstrate lower bank lending share, using a model founded on both erroneous data and wild leaps to conclude in a fit of circular reasoning that more nonbank lending explains why there is less bank lending. In the study’s words, “intermediaries themselves have adjusted their business models.” What might have led banks to decades of technological intransigence and strategic indolence is neither clearly explained nor verified.

What …

26 02, 2024

Karen Petrou: The Unintended Consequences of Blocking the Credit-Card Merger

Eliza Allen2024-04-12T09:46:02-04:00February 26th, 2024|The Vault|

There is no doubt that the banking agencies have approved all too many dubious merger applications along with charter conversions of convenience. However, the debate roiling over the Capital One/Discover merger harkens to an earlier age of thousands more prosperous small banks all operating strictly within a perimeter guarded by top-notch consumer, community, and prudential regulators. Whether this ever existed is at best uncertain. What is for sure is that all this nostalgia for a halcyon past will hasten a future dominated by GSIBs and systemic-scale nonbanks still operating outside flimsy regulatory guardrails.

The best way to demonstrate this awkward certainty is to run a counter-factual – that is, think about what the world would look like if opponents of the Capital One/Discover deal get their way. Would we quickly see a return to card competition housed firmly within a tightly-regulated system? Would the payment system be loosed from Visa and Mastercard’s grip? Would merchants see the dawn of a new era of itsy-bitsy interchange fees? Would card rates plummet and rewards stay splendiferous? I very much doubt it. Space here does not permit a detailed assessment of the analytics underlying my conclusions, so let’s go straight to each of them.

First, banning the CapOne/Discover deal would not ensure robust card competition under strict bank regulation. JPMorgan’s and American Express’ formidable stakes could grow because credit-card lending is a business dependent on economies of scale and scope vital to capital-efficiency through the secondary market. However, large banks will …

8 01, 2024

Karen Petrou: Reflections on Regulatory Failure and a Better Way

Eliza Allen2024-01-08T11:25:21-05:00January 8th, 2024|The Vault|

Earlier today, we released our 2024 regulatory outlook, a nice summary of which may be found on Politico’s Morning Money. As I reviewed the draft, I realized how much of what the agencies plan is doomed to do little of what has long been needed to insulate the financial system from repeated shock. This is a most wearisome thought that then prompted the philosophical reflection also to be found in this brief. It asks why lots more bank rules do so little for financial resilience yet are always followed by still more rules and then an even bigger bust. I conclude that financial policy should be founded on Samuel Johnson’s observation that, “when a man knows he is to be hanged in a fortnight, it concentrates his mind wonderfully.” That is, redesign policy from one focused on endless, ever-more-complex rules spawning still larger bureaucracies into credible, certain, painful resolutions to concentrate each financial institution’s mind and that of a market that would no longer be assured of bailout or backstop.

We know in our everyday lives that complex rules backed by empty threats lead to very bad behavior. For example, most parents do not get their kids to brush their teeth by issuing an edict reading something like:

It has long been demonstrated that brushing your teeth from top to bottom, tooth-by-tooth, flossing hereafter and using toothpaste meeting specifications defined herein will achieve cleaner teeth, a brighter smile, improved public acceptance of the tooth-bearer, and lower cost to …

11 12, 2023

Karen Petrou: Unicorns, Zombies, and Capital Regulation

Eliza Allen2023-12-11T10:23:04-05:00December 11th, 2023|The Vault|

As was again clear at last week’s Senate Banking hearing, credit availability is much on the mind when it comes to LMI communities and small business. This makes a good deal of sense given the capital proposal’s unintended consequences, but it’s only part of the story. When start-up ventures are unable to get bank loans, they turn to the capital market. This is often necessary due to the start-up’s risk, but in recent years it’s also been driven by hundreds of billions of investor dollars desperately chasing higher yields as the Fed year-in, year-out kept real rates below zero. Now that rates are finally, really positive, yield-chasing funds have evaporated. As the New York Times made clear, unicorns have turned into zombies. Some of the walking dead deserved to die long ago, but the flood of capital-markets funds exiting this sector also strands ventures that could and should have been vital innovators. Had these entities been buoyed by bank loans as soon as they were viable, many would still be walking.

Not every zombie is an innovator we’ll sorely miss. Many bet big on not-so-critical products such as still more scooters. However, one sector left high and dry – early-stage biomedical research – is literally a matter of life and death.

In February of 2021 when the economy was growing but real yields were negative, the total enterprise value of approximately 700 publicly-traded biotechs was $598 billion. As of the latest data, this is down to $213 billion …

8 12, 2023

American Banker, Thursday, December 7, 2023

Eliza Allen2023-12-08T10:13:03-05:00December 8th, 2023|Press Clips|

Operational risk emerging as linchpin of Basel capital debate

By Kyle Campbell

What had for months been a broad debate around the wisdom and process of the Basel III capital proposal has narrowed in recent weeks to center on a particular aspect of that proposal: capital retention for banks’ operational risks…Karen Petrou, managing partner at Federal Financial Analytics, said capital is a “poor palliative” for operational risks, because it is different from other types of risks…. “Operational risk is very different from credit and market risk. It’s equivalent to what you do when the lights go out, and the approach that somehow, if you have a pot of money, you will see better is nonsensical,” Petrou said. “What you actually need is a generator, and that costs money.” … But Petrou notes that the rule retains the seven categories of operational risk — internal fraud, external fraud, employee practices and workplace safety, products and business practices, damage to physical assets, systems failures and process management — remain unchanged by the proposal. She also noted that the best way to address future risks is not to look at past outcomes, but for bank supervisors to diligently manage existing risks. “These rules reflect the fact that regulators don’t trust themselves,” Petrou said. “They’re using capital as a stand-in for effective supervision, which would be far more effective when it comes to operational risk.” … Petrou said the issues presented by the proposed treatment of operational risks could not be …

4 12, 2023

Karen Petrou: Why Curbing Banks Won’t Curtail Private Credit

Eliza Allen2023-12-04T11:03:15-05:00December 4th, 2023|The Vault|

Last Wednesday, Sens. Brown and Reed wrote to the banking agencies pressing them to cut the cords they believe unduly bind big banks to private-credit companies. The IMF and Bank of England have also pointed to systemic-risk worries in this sector, as have I. Still, FSOC is certainly silent and perhaps even sanguine. This is likely because FSOC is all too often nothing more than the “book-report club” Rohit Chopra described, but it’s also because it plans to use its new systemic-risk standards to govern nonbanks outside the regulatory perimeter by way of cutting the banking-system connections pressed by the senators. Nice thought, but the combination of pending capital rules and the limits of FSOC’s reach means it’s likely to be just thought, not the action needed ahead of the private-credit sector’s fast-rising systemic risk.

One might think that banks would do all they can to curtail private-credit competitors rather than enable them as the senators allege and much recent data substantiate. But big banks back private capital because big banks will do the business they can even when regulators block them from doing the business they want. Jamie Dimon for one isn’t worried that JPMorgan will find itself out in the cold.

Of course, sometimes banks should be forced out of high-risk businesses. There is some business banks shouldn’t do because it’s far too risky for entities with direct and implicit taxpayer backstops. This is surely the case with some of the wildly-leveraged loans private-credit companies …

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