The Vault

Last week, the American Banker had a synopsis of views filed on Treasury’s request for comments on digital-finance regulation.  Its quote from the ABA’s comment letter is striking, indicating that this letter pointed to the increasingly-absurd reality of no rules for nonbanks and no digital assets for banks given all their rules.  Progressive advocates pushed back, arguing that it’s right to keep banks quashed because of all the systemic hazards they pose.  To my thinking, both sides are right, with recent history not just showing why, but also how urgent it is for regulators finally to act on both overarching crypto rules and those governing bank exposures in this volatile sector.

The recent history I have in mind is the chilling precedent of subprime mortgages starting in around 2003.  I well remember a meeting at the OCC in which my late husband detailed both the borrower and market risks of new mortgage products such as those with “silent seconds” extended to borrowers with no demonstrable ability to repay even a first line from resources other than the ever-appreciating house prices investors somehow believed were a force of nature that always blew balmy winds their way.

The OCC official with whom we spoke was even more worried than we about emerging market trends, but she was over-ruled from on high.  This was first because national banks weren’t sounding the alarm, second because no other banking agency seemed worried, and finally because anything that adversely affected national banks might have undermined …

In our recent paper outlining the holistic-capital regime regulators should quickly deploy, we noted that current rules are often counter-productive to their avowed goal of bank solvency without peril to prosperity.  However, one acute problem in the regulatory-capital rulebook – procyclicality – does particularly problematic damage when the economy faces acute challenges – i.e., now.  None of the pending one-off capital reforms addresses procyclicality and, in fact, several might make it even worse.  This memo shows how and then what should be quickly done to reinstate the counter-cyclicality all the regulators say they seek.

Last Thursday, the Fed set new, often-higher risk-based capital (RBC) ratios for the largest banks.  The reason for this untimely capital hike lies in the interplay between the RBC rules and the Fed’s CCAR stress test.  Packaged into the stress capital buffer (SCB), these rules determine how much RBC each large bank must hold to ensure it can stay in the agencies’ good graces and, to its thinking, better still distribute capital.

Put very simply, the more RBC, the less RWAS – i.e., the risk-weighted assets, against which capital rules are measured.  The higher the weighting, the lower a capital-strained bank’s appetite to hold it unless risk is high enough also to offset the leverage ratio’s cost – at which point the bank is taking a lot of unnecessary risk to sidestep another set of unintended contradictions in the capital construct.  As a Fed study concludes, all but the very strongest banks sit on their …

As seems increasingly the case, I spent more time last week than hoped with airport personnel.  In the course of the economic-inequality discussion that prompted my travels, I mentioned that I had little confidence in the general-public inflation expectation data in which economists put such stock.  So, I asked my aide what she thought and was told that her biggest fear is the “rising price of the dollar” and whether she will thus be able to afford her apartment and get her kids ready for school.  The airport was packed and she is turning down overtime, but she has to take care of her kids and day care costs are higher than even more pay can manage.  Pressing on, I got only a blank stare following mention of the Federal Reserve but then heard a diatribe about useless politicians including those she no longer thinks care for anyone but themselves.  I think this lady’s views are emblematic of lower-wage workers who once were active voters and thus also an important warning signs not only of how unequal economies work at odds with the Fed’s macro models, but also of the outcome of the election this year and, should things only get worse, then in 2024.

I decided not to waste time by asking Kisha (not her real name) to agree that the recession is just an illusion because all the data boxes have yet to be checked as the President, Treasury Secretary, and Fed chairman insist.  It’s hard to think …

Although a new paper by former FRB Gov. Tarullo and Fed staffers on the FHLB stirred considerable consternation across the Federal Home Loan Bank System, it’s a crushing and persuasive critique of a giant GSE that has long preferred to go unnoticed.  That’s not unreasonable since the System has evolved from an essential small-bank funding source for mortgages into a taxpayer-subsidized capital-markets investment option.  When public wealth is not allocated for public welfare, resources are misallocated and market integrity is compromised.  But, unless the Home Loan Banks blow themselves up, they are here to stay.  Thus, the policy challenge is not how to abolish them, but how best to redirect an established funding channel back to servicing the public good.  Traditional single-family mortgages don’t need the Banks anymore, but much else does.

The paper’s criteria for considering taxpayer subsidies are a very helpful guide for moving forward and thus worth quoting at length:

“There is, of course, nothing inherently wrong with government subsidies. But subsidies should meet two conditions if they are to be sound public policy. First, they must be shown to be correctives for identified market failures or instruments of targeted redistribution policies.  Second, there must be governance mechanisms to ensure that the subsidies are used to achieve the ends specified by the legislature or regulator, and not for other purposes.”

I suspect the authors would agree with a third point:  if a credible, forward-looking case for the subsidy cannot be made by virtue of demonstrable public benefits …

As part of its response to the President’s digital-asset executive order, the Department of the Treasury is seeking views on the broad policy questions on which it believes answers might guide the Administration’s next steps. The definition of digital assets on which comment is sought includes central-bank digital currency (CBDC) and other digital representations of value delivered via distributed ledger technology (DLT). As a result, Treasury’s inquiry is comprehensive and results could have far-reaching implications, but the nature of the questions posed are so broad as to provide little indication of how Treasury plans to frame its report to the White House and proceed thereafter.

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Late last week, we released a new issue brief laying out how to quickly take Michael Barr’s suggestion of a holistic regulatory-capital regime from rhetoric to reality.  The American Banker did a fine job summarizing the paper and putting it into the policy context, generating a lot of questions to which I’ll turn in this memo.  By far the most common assertion is that this paper is a stealth big-bank campaign to cut regulatory capital.  If it is, that’s news to all of them, as they saw the paper about the same time the Banker article appeared.  More to the point and as I’ll discuss below, a holistic-capital regime wouldn’t come cheap, it would just be better honed and more effective.

The paper was sparked by what might have been an offhand comment from Mr. Barr at his Senate confirmation hearing for the Fed’s supervision vice chair.  He was asked his views on the “Basel IV” package of regulatory-capital rewrites and said that he favored thinking about capital as a whole rather than finalizing individual standards in the absence of a broader vision.  Or that’s what he seemed to mean because, sensible man that he is, the less said at a confirmation hearing, the better, and talk quickly turned to other matters.  Assuming he meant what we thought he said, FedFin did our best to give it legs.

We did so in part by providing a short taxonomy of key capital requirements showing how they relate to other capital requirements …

The Federal Reserve Bank of Philadelphia’s latest report on foreclosure risk includes a worrisome finding:  the sharp rise in interest rates means that most loan-mod recipients won’t actually get much relief.  This combined with troubling data on GSE loan-mod results and racial equity could spur FHFA intervention if market conditions worsen…

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The FDIC is proposing to raise base Deposit Insurance Fund (DIF) assessments by two basis points (BPS) to replenish the DIF by the statutory deadline to reflect deposit inflows that the FDIC no longer expects to be temporary.  Even after the DIF reaches its minimum ratio, the added assessments would continue to restore the fund to a more ample reserve.  This will increase costs at insured depository institutions (IDIs), in some cases likely by sizeable amounts likely to alter business strategy in ways that might dampen economic growth….

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My interview late last week with NPR’s Marketplace on the CFPB’s assault on credit-card fees sparked considerable comment mostly about how much people hate their credit-card fees.  What’s at stake here, though, is not one fee – it’s the impact of a paradigm shift in the construct of U.S. consumer-finance regulation.  If Rohit Chopra has his way – and he may well – consumer financial-protection standards will be transformed from reliance almost exclusively on disclosures into a federal construct of price-setting and product prohibitions.  Political ideology may dictate a preference between these paradigms, but a choice that enhances effective consumer protection isn’t that simple – disclosures have largely failed consumers, but nationalized consumer finance could crush consumer banks.

Historically, U.S. consumer-financial protection law depends on disclosure.  Indeed, transformational law were called the “truth-in” acts because Congress believed that making financial providers tell the truth would set consumers free from predatory practice.  Congress also understood that some practices were ill-governed by pages of ex ante paperwork or seemingly-comparable terms and thus set standards – when payments must be in hand – or provided express protections – $50 maximum charges for transactions that go astray.  However, with few exceptions mostly instituted in 2010 after the crash, Congress did not allow regulators to set prices or prohibit even egregiously predatory products.  Look for example at the Home Ownership Equity Protection Act, which principally required disclosures and did nothing to staunch high-risk mortgage finance and the crisis it fostered.

It’s thus understandable that Rohit …

As we expected, today’s Senate Banking session with Chairman Powell is a preview of broader national debate ahead of the midterm election.  Democrats generally sought to emphasize their understanding of inflation’s costs without lambasting the Fed and, indirectly, the Biden Administration.   Still, Sens. Ossoff (D-GA) and Warnock (D-GA) pressed Mr. Powell on the Fed’s failure to begin to tighten last summer.  Republicans were strongly united in lambasting….

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