Shane Smith, Author at Federal Financial Analytics

29 04, 2024

Karen Petrou: The Inexorable, Inadvertent Inequality Vise

Shane Smith2024-04-29T09:18:06-04:00April 29th, 2024|The Vault|

Last week, we sent you an analysis of a new Fed study reinforcing previous research, my own included, finding that U.S. economic inequality exacerbates financial instability. Notably, this paper added an important, novel element: the extent to which economic inequality increases the role of NBFIs and thus heightens systemic risk even more than was the case when banks ran the financial show. But does economic inequality lead to greater NBFI reliance and resulting risk or do NBFIs on their own have a still more pernicious inequality effect that makes the risk of financial crisis still more acute? In short, yes – this is a potent negative-feedback loop of prodigious power.

What makes this feedback loop reverberate so dangerously? More research is essential, but breaking down the income and wealth components of economic inequality into the key drivers of systemic risk along with the regulatory and monetary-policy determinants of financial-sector competitiveness suggests a causal connection between more inequality leading to more NBFIs and more risk leading to more inequality and still more NBFIs and then heightened financial risk and consequential inequality.

In super-short, income inequality is determined in part by wage/salary and capital (i.e., investment) income. The more income from whatever source, the better for buying what one needs and wants unless recessions, progressive taxation, or other personal or policy actions prevent the cumulative increases in income that power up spending and, still more importantly, generate wealth.

Wealth equality is judged by net worth – that is, how much you have …

22 04, 2024

Karen Petrou: Credit-Card Surcharges: One Inflationary Culprit the CFPB Could Catch

Shane Smith2024-04-22T09:29:18-04:00April 22nd, 2024|The Vault|

One could go on – indeed many do – about whether inflation is showing enough signs of a slow-down to warrant lower interest rates. I’ve said before that lower rates won’t have the housing-affordability benefits advocates expect, but this doesn’t address the underlying issue of just how hot inflation may be running. I’m not sure if anyone – including the Fed – really knows, but battles on my neighborhood listserv validated by growing data make clear that federal data overlook one hidden price hike driving more and more Americans flat-out crazy: credit-card surcharges that are nothing but shadow price hikes of as much as four percent.

In fact, card surcharges are the epitome of the “junk” fees the CFPB has vowed to quash. The credit-card late fees the Bureau lambasts are due to consumer sins of omission or commission – i.e., consumers have the ability – I would say obligation – to keep their card debt within amounts they can honor as well as the choice to pay on time. How much should be charged for paying late is obviously a point of discussion, but that consumers have a duty to pay on time is indisputable.

In sharp contrast, card surcharges are often unavoidable and ill-disclosed. The neighborhood listserv is something of a group rant, but it does include interesting illustrations of hidden credit-card surcharges that are often – think car-repair shops – meaningful and material add-on prices discovered only after the fix, quite literally, is in.

D.C. is an …

15 04, 2024

Karen Petrou: The FDIC Plan to End Too-Big-to-Fail Brings Promise of More Bailouts

Shane Smith2024-04-15T09:41:37-04:00April 15th, 2024|The Vault|

In 2013, the FDIC issued a short, unilluminating paper purporting to show how the agency would implement one aspect of the orderly-liquidation authority (OLA) Congress granted in 2010 to prevent the profligate bailouts that blighted the great financial crisis. I was unconvinced by the 2013 paper and even more perplexed when years passed and the utterance on single-point-of-entry (SPOE) resolutions was all the FDIC deigned to pronounce. After all, if big banks and systemic nonbanks can’t be closed without bailouts, then moral hazard triumphs and crashes become still more frequent and pernicious. Last week, mountains moved and Chair Gruenberg said that anything big will not be bailed out. Would this were true, but it’s not.

Despite the agency’s failure last year to find a solution other than a bailout for high-risk regional banks and an Inspector-General report finding the FDIC most OLA-unready, the FDIC now is confident that it can handle even the biggest blow-out at U.S. global systemically-important banks. This derives from untested faith in SPOE, the FRB’s TLAC rule, GSIB living wills, and what it calls legal certainty pertaining to qualified financial contracts (QFCs).

Maybe so re GSIBs, but this sangfroid is still more puzzling when one reads on and finds that the FDIC thinks so well of its GSIB OLA capabilities that it says that it’s also ready to deploy them for foreign-GSIB operations in the U.S., any regional bank that hits a systemic bump, and even nonbank SIFIs. Nothing is said about the fact that …

8 04, 2024

Karen Petrou: Why Lowering Interest Rates Now Makes Housing Even More Unaffordable

Shane Smith2024-04-08T09:30:15-04:00April 8th, 2024|The Vault|

As we’ve noted, Sen. Warren and a raft of progressive Democrats are emphatically demanding that the Federal Reserve lower interest rates to promote affordable housing. However, as a new Federal Reserve Bank of Dallas note confirms, low rates don’t necessarily make it easier to buy a home because house prices generally rise as rates fall. Worse still, ultra-low real rates eviscerate not just the ability of all but the well-heeled and -housed to save for a down payment, but also for much else that ensures economic resilience and long-term security. Simply put, lower for longer makes the U.S. still more economically unequal, not exactly what progressives want.

The assumption in Sen. Warren’s letter and a like-kind one from Chair Brown is that lower mortgage rates reduce the carrying cost of a mortgage and thus make it easier for lower-income households to qualify for a loan. However, this seemingly-obvious conclusion assumes that housing markets are static and, as any real-estate agent will tell you, they aren’t.

When rates go down, demand goes up and prices do the same. Or, as the Dallas Fed study observes, a one-percentage-point hike in short-term rates usually lowers house prices by 7.5 percent over two years. Just as intuition suggests that easy money spurs homebuying, so it is that tight money reduces demand and prices respond accordingly.

Or, they do in a normal market and there haven’t been any of these since the Fed sent interest rates below inflation-adjusted zero in 2008 and kept them …

18 03, 2024

Karen Petrou: The OCC Blesses a Buccaneer Bank

Shane Smith2024-03-18T09:03:04-04:00March 18th, 2024|The Vault|

In a column last week, Bloomberg’s Matt Levine rightly observed that only a bank can usually buy another bank. He thus went on to say that a SPAC named Porticoes ambitions to buy a bank are doomed because Porticoes isn’t a bank. Here, he’s wrong – Porticoes in fact was allowed last December to become a unique form of national bank licensed to engage in what is often, if unkindly, called vulture capitalism. This is another OCC charter of convenience atop its approvals leading to NYCB’s woes, and thus yet another contradiction between the agency’s stern warnings on risk when it pops up in existing charters versus its insouciance when it comes to new or novel applications.

According to the OCC’s charter approval, the Porticoes bank has no other purpose than serving as a wholly-owned subsidiary of Porticoes Capital LLC, a Delaware limited-liability company formed to be a proxy for a parent holding company. The parent holdco is “expected” to enter into binding commitments for the capital needed to back its wholly-owned bank plans to acquire a failed bank or even banks. This is essentially a buy-now, pay-later form of bank chartering, a policy even more striking because funding commitments for the holdco then to downstream – should they materialize – are more than likely to come from private-equity investors who may or may not exercise direct or indirect control.

Based on the OCC’s approval, it seems that Porticoes’s new charter can buy another bank without capital, pre-approval from …

20 02, 2024

Karen Petrou: How the OCC Made a Bad Bank Both Bigger and Badder

Shane Smith2024-04-12T09:48:06-04:00February 20th, 2024|The Vault|

As I noted last week, the OCC’s proposed bank-merger policy fails to reckon with the strong supervisory and regulatory powers federal banking agencies already have to quash problematic consolidations and concentrations. Here, I turn to one reason why the OCC may not trust these rules: it doesn’t trust itself. A bit of recent history shows all too well why this self-doubt is warranted even though it’s also inexcusable.

I owe my historical recall to the authoritative Bank Reg Blog, which last week looked at the latest on NYCB. This included a troubling reminder of the troubled bank’s merger with Flagstar before it thought it snapped up another great deal from the FDIC via acquiring what was left of Signature Bank.

NYCB first sought approval for the Flagstar acquisition in 2021 when its primary federal regulator was the FDIC. As is often the case with merger applications, this one appeared to go into a dark hole. Unlike many other acquisitions, the banking companies had a go-to Plan B: charter conversion.

NYCB went to the OCC and got rapid approval not just for converting its charter to a national bank, but also then for acquiring Flagstar via a reverse flip that also involved a Flagstar conversion to a national charter. The OCC then readily approved the merger in 2022, just in time for some of the super-rapid growth via the Signature deal both the OCC and FDIC approved even though they should have been well aware that rapid-fire mergers almost always lead …

12 02, 2024

Karen Petrou: How to Have Sound Bank-Merger Policy Reflecting Unique Bank Regulation

Shane Smith2024-04-12T10:31:00-04:00February 12th, 2024|The Vault|

Chair Powell said a week ago that, thanks to commercial real estate risk, some banks will need to be “closed” or “merged out of existence,” hopefully adding that these will be “smaller banks for the most part.” That this may befall the banking system sooner than Mr. Powell suggested is all too apparent from NYCB’s travails. The OCC’s new merger proposal flies in the face of this hard reality, dooming mergers of size or maybe even small ones until it’s too late. A surprising source – a super-progressive analysis of bank merger policy – makes it clear why the OCC’s approach is not only high-risk, but also ill-conceived.

The paper comes from Saule T. Omarova, President Biden’s nominee to be Comptroller who was forced to withdraw, and the Administration’s most recent Assistant Secretary for Financial Institutions, Graham Steele. As befits their longstanding views, the paper presses for stringent bank-merger policy to combat what Justice Brandeis first called the “money trusts.” Ms. Omarova and Mr. Steele say that banks of all sizes are still “money trusts” despite the role of omnipotent private-equity and asset-management firms, but so goes much of their analysis. What’s more interesting in their report and a new petition filed by a like-minded academic is their ground-breaking, hard look at how much of bank regulation is actually intended to curtail undue market power. Taking this into account could lead to sound merger policy without the adverse consequences evident in the OCC’s drop-dead proposal.

There are in fact many …

5 02, 2024

Karen Petrou: Why Lower Rates Won’t Lead to More Affordable Housing

Shane Smith2024-04-12T10:31:58-04:00February 5th, 2024|The Vault|

As Politico rightly pointed out last week, the inability of anyone who doesn’t already own a home to get one is turning into a significant political problem for incumbents of all persuasions. It might also come to be one for the Federal Reserve based on a call I got from a senior senator a couple of weeks ago. This is not exactly what the Fed needs given how hot a political potato it’s already become.

Having read my economic-inequality book, the senator called to ask if I thought the Fed had any responsibility for the acute shortage of affordable housing. As in all too many other states, his has seen a migration of teachers, first responders, and the middle class as a whole from cities and resort areas, with these vital workers forced to live hours from their jobs and thus in a state of perpetual commuting which they fear puts their children at risk.

This isn’t news, but it’s worse than ever and thus not just a daily grind for many Americans, but also a serious political threat to this moderate Democrat. His state is deep purple and he believes it’s getting redder by the minute thanks to Donald Trump’s ability to mobilize voter anger on day-to-day economic challenges such as the critical one facing those who cannot find affordable, desirable housing within reasonable distance of their jobs.

As might be expected, the senator wasn’t calling to ask an academic question; he wanted to know not just …

29 01, 2024

Karen Petrou: The Risks New Capital Rules Can’t Cure

Shane Smith2024-01-29T09:29:45-05:00January 29th, 2024|The Vault|

Part one of my end-game assessment was last week’s memo laying out the growing odds that the agencies will be forced to issue a new proposal which hopefully makes better sense than the current one. Part two here points out how the agencies have so tightly wrapped themselves around the capital rule’s axle that they are unable to see how many even more critical challenges are going unaddressed. Risks overlooked are often risks even the toughest capital rules cannot contain because the cost of new capital rules actually contributes to the arbitrage and risk-migration accelerating the pace of systemic-risk transformation. This is a negative feedback loop if ever there were one.

The new capital rules will be outdated by the time they are finalized because financial institutions of all persuasions will take advantage of every bit of regulatory-arbitrage opportunity within and across borders. That the banking agencies and FSOC aren’t even thinking about how this might happen makes it still more likely that they will. This is not to say that no changes to capital rules are warranted. Some changes are overdue, but capital rules crafted in a vacuum will not stand up to real-world circumstance.

The collective book reports issued by the Federal Reserve in its semi-annual systemic forecast and the FSOC’s annual reports are remarkably backward-looking. Focused more on not saying anything too frightening and bolstering ongoing initiatives, these tomes have long been and sadly still are poor auguries of risks to come perhaps all too soon.

Even …

22 01, 2024

Karen Petrou: How the Banking Agencies Dealt Themselves Such a Weak End-Game Hand

Shane Smith2024-01-22T09:22:56-05:00January 22nd, 2024|The Vault|

We said from the start that finalizing the capital rules as proposed would be difficult because I have truly never seen a sweeping rule buttressed by such shoddy analytics. It’s of course true that lots of rules make little sense, but rules that cost companies as much as the capital rules are uniquely vulnerable to substantive and legal challenges. This is even more likely when, as now, the proposal’s victims know how to temper political claims with well-founded assertions of analytical flaws and unintended consequences. When regulatory credibility is effectively undermined, even those who might otherwise side with the regulators become cautious, if not actually averse to doing so. And thus, it has come to pass for the end-game rules.

As our analyses of all of the comment letters filed last week by dozens of Democrats make clear, only a few super-progressive Democrats now stand firmly with the regulators and even they have a few qualms. Maybe the agencies will try to bull it out – we thought so as recently as early this month in our outlook. We were clear there that major changes would need to be made to finalize the end-game rules; now, we’re not sure even these will do. The odds now are considerably higher for the re-proposal pressed last week by FRB Govs. Waller and Bowman.

The agencies are of course not naïve. They knew that the final rule would have to show a few concessions to its critics. As a result, …

Shane Smith

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