The Vault

Joe Biden is even older than I am, so he surely remembers inflation’s searing political costs in the late 1970s: President Jimmy Carter’s loss to a candidate, Ronald Reagan, who promised to align an anti-inflation fiscal policy with the bazookas already firing full force at Paul Volcker’s Fed. What does this mean for Joe Biden? A fundamental axiom of political decision-making is that politicians maximize their own advantage at all times sure as they do so that what’s good for them is also good for everyone about whom they care. Combine the history of the late 1970s with this seemingly-eternal axiom and one knows what Joe Biden will do: he will make his Fed pick based on where he sees his political advantage. If inflation is not proving itself truly transitory by the time this call lands in his hands, even the formidable powers pushing Mr. Powell may not prevail.

The old political lesson of inflation’s costs to those who hold office are already evident. Republicans are finding that blaming Democrats for inflation is their most effective advertising against moderate Democrats in swing seats. A poll released late last week also shows inflation now ranks as the top economic concern for Republicans, with Democrats listing it second behind only income inequality. And, if one wants an even more direct bellwether of inflation’s political impact, see Sen. Joe Manchin’s letter to Jerome Powell, directly challenging the Fed chairman because of rising inflation the senator doubts will prove transitory in the sectors …

Today’s Senate Banking hearing on bank supervision did not include FRB Vice Chairman Quarles, who came before the panel for withering criticism earlier this year (see Client Report REFORM206). Acting Comptroller Hsu, FDIC Chair McWilliams, and NCUA Chairman Harper received a considerably warmer welcome from Democrats, although Ranking Member Toomey (R-PA) blasted the OCC for what he called politicization of bank supervision and urged all the agencies to leave the CRA rulebook as is.  Chairman Brown (D-OH) attacked bank regulation prior to the arrival of the Biden team, by inference continuing his criticism of Chairman Powell’s regulatory approach (see Client Report FEDERALRESERVE63).  Under questioning, Mr. Hsu announced that his agency is reviewing overdraft fees; while he did not say in which context, it would appear to be with an eye on the extent to which earnings reliance on them may be unsound, but reputational-risk considerations may also be renewed.

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Whatever befalls the Senate infrastructure bill, we believe its $21 billion GSE pay-for is but one bit of a bigger de facto transformation of the GSEs.  We know of course that the Trump Administration’s near-term privatization is no more.  But, what’s emerging now is incremental nationalization redefining Fannie and Freddie in ways that make unravelling their quasi-official status still more uncertain.  We continue to think that the Biden Administration will opt for a utility along Obama lines, but that’s only if they think about the GSEs in anything other than a utilitarian way – which so far they have not.

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A while back, I described the “illusion of inclusion” – what happens when financial products reach under-served consumers or investors largely due to terms that advantage the provider instead of the customer, advertising that a product has vital protections such as FDIC insurance, little of the customer-servicing capacity needed to prevent undue loss, or the vulnerable are otherwise persuaded to take a chance that’s just too good to be even close to true. The events this week show that some policymakers are taking notice, but the notice is so limited and the risks so large that much more is required before still more of the financially fragile are put at even greater risk.

First, Senate Banking Chairman Brown called on the CFPB to investigate not just one nonbank claiming to be a bank even as it summarily closed consumer accounts, but also for a review of all nonbanks now outside the reach of critical consumer-protection safeguards.  Second, state securities enforcers struck out at BlockFi, a crypto company opening what purports to be savings accounts paying a 7.5 percent rate of interest on crypto assets.  All of the “depositors” and “investors in these “bank” accounts think that the new provider will beat all the old, tired, low-rate offers, as are Robinhood’s customers.  Very few of them can, though, afford to take a real risk – Robinhood’s investors aren’t merry men; they instead have a median investment of only $240 with this fun firm.

The problem here isn’t just a …

In its semiannual report to Congress earlier this month, the Federal Reserve said that, “No notable effect on Treasury market functioning followed the expiration in March 2021 of temporary changes to the supplementary leverage ratio, which were implemented to ease strains in Treasury market intermediation in the initial weeks of the pandemic.”  This is technically correct, but substantively misleading.  While it’s certainly true that nothing untoward has since befallen the Treasury market, it’s also noteworthy that securing this happy outcome necessitated expansion of the Fed’s overnight reverse repo program (ONRRP) to almost a trillion dollars.  A trillion dollars – and the ONRRP could still get bigger – is no technicality nor is the ONRRP just some new curtain for a Fed window – it’s an unprecedented market backstop that increases moral hazard to levels yet unknown.

It’s tempting to suggest that the Fed pulled this sleight of hand about Treasury-market stability to duck the thorny question of exemptions to the supplementary leverage ratio (SLR).  As the sentence above notes, the Board did not renew these exemptions in March, thus bringing central-bank deposits into the SLR denominator at all but the custody big banks and altogether ending the leverage exemption for Treasury obligations.  When it pulled this plug, the Fed said it would review the SLR this summer, but summer’s waning and signals from the central bank increasingly suggest so too is any SLR rewrite.

The politics of such a change is fraught, at the least complicating President Biden’s decision …

The banking agencies have proposed sweeping standards that would hold all of the banking organizations they govern responsible for the safety and soundness, consumer compliance, and perhaps even diversity of a wide range of third-party business arrangements that now expressly bring in affiliates, subsidiaries, and parent holding companies along with the full scope of outsourced product and service relationships, marketing partnerships, joint offerings, and even use of a third-party mobile phone platform. Much of what would be required of banks may be feasible within contractual relationships, but the guidance would apply even when there is no exchange between the bank and a third party.

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On Wednesday, Rep. Ritchie Torres pressed Chairman Powell on several key points in my Monday New York Times opinion piece on the Fed’s unintended, but important, economic-inequality impact.  The chairman stoutly defended the Fed, at one point complaining that it could not be true that low rates increase wealth inequality because no low-income people have said so to the Fed.  This is new – the Fed has never before announced a crowd-sourced policy construct.  But, be that as it may, Mr. Powell’s other points deserve a serious, substantive reply.  In very short, it might be true that ultra-low rates enhance economic equality if they demonstrably improved income equality via gainful-employment increases large enough to offset growing wealth inequality resulting from the impact of negative real rates on small-dollar savings and broader financial dislocations.  Problem is, this didn’t happen from 2008 through 2021, long enough to tell.

Rep. Torres first quotes my article, correctly saying it asserts that ultra-low rates benefit investors, not savers.  Without addressing what I was talking about – wealth inequality – Mr. Powell emphatically disagrees, saying that low rates “support a strong labor market.”  He then went on to take credit for “record” employment at the end of the last decade.  But, even the Fed has since acknowledged that “employment” may well have been anything but record-breaking when employment is properly measured – see Mr. Powell’s own mea culpa on that earlier this year.

And, of course, income equality isn’t just about having jobs however the …

What do you get when you finally have a global proposal to govern money-market funds (MMFs), a gigantic 2020 Fed intervention backing up a sector that also needed help in 2008, and an overnight reverse-repo program (ONRRP) trending towards a trillion?  Tough U.S. MMFs standards, that’s what.

Two in-depth FedFin reports this week assessed both the length and breadth of the Financial Stability Board’s consultation and its impact on the agency-debt market.  These both make it clear that the FSB has now decided against another round of toe-to-toe combat with the asset-management industry.  After the 2008 crisis and the fund rescues that followed, global regulators fought for systemic-designation criteria, activity-and-practice identifiers, and other standards to bring the sector under what it strongly insisted was inappropriate, unnecessary, and unduly bank-like standards.  So matters rested until the aforesaid 2020 crisis.

COVID of course wasn’t the fault of MMFs, but the fragility it uncovered did as much damage to their reputation as to that of previously-somnolent national health authorities.  Revisiting the battlefield in hopes of not also repeating its defeats, the FSB thus proposes to give national jurisdictions an array of options to govern MMFs in hopes some of them will then do something.  Some jurisdictions will take a pass, but these won’t include the U.S.

The Fed has been on the MMF warpath since 2008, losing a pitched battle with the SEC only after the Obama Treasury Department’s FSOC unsuccessfully sought to get the Commission to do much of …

Our recent in-depth analysis details the range of options proposed by the Financial Stability Board for MMF reform. Here, we assess what this means for Fannie, Freddie, and the FHLBs. In short, it depends on what these GSEs turn out to be but as long as they are agencies, MMF reform should ensure low-cost funding and a big edge on everyone else, many banks included.

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