The Vault

Welcome to The Vault. Every week you’ll find a sample of FedFin opinion and analysis on the most recent issues facing financial services firms. Check back frequently to see what’s new. Click here to contact us.

22 01, 2024

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

2024-01-22T09:22:56-05:00January 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, …

17 01, 2024

FedFin on: New Fed Study: Stringent Rules, Certain CBDCs Accelerate Shift to Shadows

2024-01-18T09:35:44-05:00January 17th, 2024|The Vault|

A new Fed staff paper assesses monetary-policy transmission in a world of CBDCs, stablecoins, nonbanks, and tough new bank rules.  We think this a significant advance in Fed research because the paper’s models (see below) reflect the substitutability of bank for nonbank assets and liabilities across the broader market made still more frictionless by the Fed’s ONRRP.  We focus here on policy decisions other than those specific to monetary-policy transmission, focusing first on how the models test the impact of rules akin to Basel III, also illuminating the end-game standard impact and that of other pending rewrites.  As banks have found in practice, tougher liquidity requirements are found to lead banks away from lending to larger holdings of Treasury obligations and reserves.  This is well known, but the model also reinforces concerns about shadow banking by finding that, when banks move out, nonbanks move in with a small net deduction in total credit availability.  A similar effect is observed when modelling higher capital requirements.  The paper observes that all the new rules may well make banks safer, but the resulting larger nonbank role offsets this benefit.  New rules are also found to affect the ability of the Fed to administer rates through interest on reserves, making the Fed more dependent on the ONRRP to transmit monetary policy – a challenge given ONRRP drawdowns as rates rise and the hopes of Gov. Waller and others at the Fed to phase it out.  In a particularly novel finding, the paper’s models also …

16 01, 2024

Karen Petrou: The Deep Cracks in the Fed’s Ever-Virginal Façade

2024-01-17T10:31:17-05:00January 16th, 2024|The Vault|

Much recent coverage assumes that the Federal Reserve is a vestal virgin when it comes to presidential elections.  In fact, history teaches us that the Fed is far from virginal even though it always slaps the hand of anyone trying to pet it in public.  This peek-a-boo strategy works only as long as policy-makers and the public accept this spotless image.  Increasingly, they don’t and not without cause.  The 2024 election will thus test the credibility of Fed “independence” and threaten it as never before.

How political is the Federal Reserve?  First, all Fed chairs are political because they would not be Fed chairs if they were not also adroitly able to advance themselves and, when it suits, also their institutions.  The best-skilled among them play politics with gusto since doing so behind the wizard’s curtain brings considerable reward even as a pristine image keeps unwelcome suitors at bay.  When this works as it often does, Fed chairs execute the monetary policy they prefer and drop wise words in receptive ears even as they demurely disavow any political thoughts on awkward fiscal- or national-policy questions when queried in the public’s eye.

This nimble strategy was widely adopted After the Fed chair in the early 1970s, Arthur Burns, delayed anti-inflation measures to keep interest rates low enough to boost Richard Nixon’s prospects.  These decisions were transparent and brought out virulent Democratic opponents of the Fed even before Mr. Burns‘ diary confirmed his political bent, damaging Fed credibility.

The “Maestro” …

12 01, 2024

FedFin: Bad, Bad Banks?

2024-01-15T09:30:18-05:00January 12th, 2024|The Vault|

A new staff paper from the Federal Reserve Bank of New York assesses the tender topic of bank mortgage lending to minority borrowers. Going beyond the usual statistics showing significant racial disparities, the paper dives into a bank-by-bank analysis of why this might be, finding significantly different and persistent fair-lending records at different banks. Controversially, it comes up with what might be called a ….

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

8 01, 2024

FedFin on: Who Gives When GSEs Go

2024-01-08T14:51:54-05:00January 8th, 2024|The Vault|

It’s not news to observe that things that change at the GSEs then change a lot of other things.  Still, the scope of the GSEs’ influence across financial markets is startling as measured by a new Federal Reserve Bank of Philadelphia study of the spillover effect of the 2020 revisions to the PSPA.  The paper looks specifically at PSPA provisions restricting GSE purchase of what the paper calls speculative mortgages (i.e., seconds and investment properties).  Push here for GSE spec loans, pull there is observed for spec loans in the private sector, all other conforming loans, jumbos, and – surprisingly – bank small-business loans.

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



8 01, 2024

Karen Petrou: Reflections on Regulatory Failure and a Better Way

2024-01-08T11:25:21-05:00January 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 …

5 01, 2024

FedFin on: U.S. Financial-Inclusion Policy

2024-01-05T09:42:53-05:00January 5th, 2024|The Vault|

As required by law, the U.S. Treasury is working to set policy enhancing financial inclusion.  While it seeks recommendations for new policies in areas ranging from predatory lending to technological innovation and new federal programs, it is unclear how actionable its findings will prove and if federal policymakers then implement those possible under current law.  However, Treasury policy will clearly not provide an overall endorsement for new technology as advocates may hope; the conclusions on which policy will be based point to technology’s potential benefits, but also numerous risks to vulnerable households and communities.

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

4 01, 2024

FedFin on: NBFI Data Reporting

2024-01-09T16:43:22-05:00January 4th, 2024|The Vault|

The banking agencies have proposed significant changes to call-reporting data illuminating how banking organizations are inter-connected with nonbank financial intermediaries and to implement pending requirements for long-term debt (LTD) issuance.  New NBFI transparency is likely to result in additional supervisory scrutiny and market discipline.

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

3 01, 2024

FedFin on: FDIC Coverage Protections

2024-01-03T10:13:44-05:00January 3rd, 2024|The Vault|

In the wake of increasing instances in which customers are confused and even misled about the extent to which fintech and cryptoasset holdings are insured deposits, the FDIC has finalized its proposal setting disclosure standards as well as modernizing IDI representations of their own FDIC-insured offerings in branches and through the fast-changing array of retail banking delivery channels. All IDIs will now have to ensure that branches, other physical locations admitting customers, ATMs, and digital/electronic-delivery channels comply with new signage and disclosure requirements….

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

2 01, 2024

FedFin on: AI Financial Risk, Rules

2024-01-02T15:24:57-05:00January 2nd, 2024|The Vault|

Bipartisan Senate legislation has been introduced to press FSOC to do more than highlight artificial intelligence (AI) as a potential threat to financial stability.  The measure instead requires the Council to undertake a rapid study of AI’s financial stability risk and report to Congress on conclusions that must then be advanced through FSOC designation and federal-agency action.  The bill also gives the SEC more authority to address at least some of the risks its chairman has identified that may be posed by predictive analytics, including AI.  New AI-related stress testing would also be likely.

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

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