The Vault

3 02, 2025

Karen Petrou: Why Playing with Treasury’s Payment System is Playing with Fire

Shane Smith2025-02-03T09:04:54-05:00February 3rd, 2025|The Vault|

In just two weeks, Donald Trump has done something no one ever expected which he may not even intend: overturning the axiomatic expectation that a full-faith-and-credit obligation of the United States government is the best there is. Now, the U.S. will honor its commitments only if it still likes them. Anything that upends financial-market axioms stokes systemic risk and stoking is now so heated that it threatens even the multi-trillion Treasury market on which U.S. prosperity and global financial stability depend.

Is this alarmist? Yes, but then who would have thought the White House would issue an edict freezing all federal funding or maybe just some federal funding even though more than just some federal funding was frozen? Who would have thought the U.S. would cease all but a very few foreign-aid payments including those with other sovereign governments no matter which geopolitical or humanitarian interests are sacrificed? Even if some of this was audible on the campaign trail, none of it was thinkable to anyone counting on constitutional checks and balances along with a sound sense by someone in the White House of second-order effects.

It is in this context that one more Trump Administration action is particularly worrisome and why I fear even for the once-sacrosanct promise that the U.S. will not just honor its commitments, but also pay its bills. Elon Musk’s acolytes at DOGE have now been granted unfettered access to the Treasury payment system. Why?

Maybe it’s just curiosity or maybe DOGE wants to update …

27 01, 2025

Karen Petrou: Why It is Hard to Damn Debanking

Shane Smith2025-01-27T09:07:41-05:00January 27th, 2025|The Vault|

As we noted last week, one of the next executive orders flying off the resolute desk in the Oval Office is likely to demand an end to debanking. In sharp contrast to the executive orders eviscerating DEI, the independent banking agencies need not follow a presidential debanking order. This affects their independent safety-and-soundness powers unlike personnel policy subject to the Executive Branch. But, independent or not, the banking agencies are nothing if not politically aware and at least two of the three agencies are also now politically-aligned with the president. It’s thus not a question of whether there will be anti-debanking standards, but rather what they do to banks trying to make a buck.

Wanting debanking doesn’t mean that getting debanking will be easy or inconsequential to the thousands of banks that never consciously debanked a dollar’s worth of deposits. One of the thorniest debanking problems derives from the fact that banks and other financial companies quite properly make business decisions based on qualitative factors, not just the quantitative ones on which anti-debanking efforts relied. Some of these qualitative factors are quite simply what makes some bankers better bankers than other bankers when it comes to decisions about whom to serve how based on expectations of future profitability. As history all too often proves, strategic insights are often at least as subjective as quantifiable.

Banks have also long chosen not to serve complex businesses that require costly underwriting and risk-management capacity unless they have the economies of scope and scale …

23 01, 2025

FedFin on: Consumer-Data Monetization

Arezou Rafikian-12025-01-24T16:55:52-05:00January 23rd, 2025|The Vault|

Shortly before the inauguration, the CFPB released a request for information (RFI) on how consumer-finance companies handle consumer data, focusing in particular on data monetization. As an RFI, this request is not directly subject to President Trump’s order affecting pending rulemakings, but a new CFPB director could withdraw or revise it. Should that not be the case, the RFI could lead the new director to reopen the agency’s open-banking rule and/or mandate new privacy opt-out notices for nonbanking entities offering consumer financial services…

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21 01, 2025

FedFin on: Elimination of the Mortgage Payment Tax Deduction

Arezou Rafikian-12025-01-21T13:59:19-05:00January 21st, 2025|The Vault|

The long list of budget options for reconciliation released by House Budget includes two with direct GSE impact as well as one – elimination of the mortgage-payment tax deduction – that would pack a major punch across the sector and is sure to be as vigorously opposed as usual. The list thus also includes a less painful and less deficit-beneficial reduction in the principal amount eligible for payment deductions from $750,000 to $500,000….

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21 01, 2025

Karen Petrou: Will There Also be a Financial Firestorm?

Eliza Allen2025-01-21T13:57:41-05:00January 21st, 2025|The Vault|

I live two short blocks from Rock Creek National Park, one of D.C.’s hidden wonders. As befits a national park, Rock Creek is very large and densely wooded, but no one has thought much about fire hazard until last summer’s drought led to some significant brush fires. I thus asked a forestry professor next to whom I happened to be seated waiting for a plane if those of us living near Rock Creek Park should worry. Instantly and unequivocally, his answer was emphatically, “Yes.” I’m still not sure what I or any of us now at risks we never contemplated can do, but I’m even less sure that what can clearly be done to reduce financial-system risk due to natural disasters will be done until after it’s too late.

Is risk really this frightening? A report last week from the Financial Stability Board lays out what it believes to be plausible, yet-severe scenarios demonstrating that the extent to which property insurers and reinsurers are able to absorb natural-disaster risk determines whether a disaster leads to systemic financial risk. In the U.S., this is a thin reed.

We know that the National Flood Insurance Program is woefully unable to address the scale of recent hurricanes and inundations. A treasury study last Friday shows that private insurance is in at least as much disarray. Homeowners in the highest climate-risk zip codes pay premiums about eighty percent higher than those in the lowest-risk codes and have far, far higher non-renewal rates. Fifteen of …

13 01, 2025

Karen Petrou: Bowman’s Most Important Regulatory Recommendation

Eliza Allen2025-01-13T12:42:41-05:00January 13th, 2025|The Vault|

Although bankers have long paid keen attention to FRB. Gov. Bowman’s regulatory thinking, public attention was sparse until last week. In the wake of Michael Barr’s resignation and speculation that Ms. Bowman might take his place as supervisory vice chair, her regulatory thinking finally got the widespread attention her monetary-policy views have long enjoyed. And a good thing too. In a speech last week, she not only reiterated comments about how best to redesign bank regulation and supervision, but also made another, unnoticed point: redesigning these key planks of financial stability need not be the blood sport they have sadly become.

Remarking on a striking change over the past year or so, Gov. Bowman rightly calls out the “adversarial” nature of recent banking-policy deliberations. This is doubtless in part because she is clearly still miffed that Mr. Barr did not engage in Board-wide collaboration, but adversarial combat extends to the Administration, Hill, and the interest groups that influence them. The press too also takes this tone, with the New York Times just last week touting new thinking about bank regulation as a big-bank triumph.

That big banks definitely wanted much of what they may now get is indisputable, but some of what they want also made sense. We know all too well that asymmetric regulation that pushes banks out of otherwise-profitable businesses gives unregulated nonbanks an unbeatable market edge that powers the migration of key intermediation functions and infrastructure beyond regulatory reach. This isn’t necessarily all that bad for …

6 01, 2025

Karen Petrou: Oval Office Bluster at a Time of Fed Confusion

Shane Smith2025-01-06T09:08:37-05:00January 6th, 2025|The Vault|

There is no doubt after last year’s last-minute debacle that U.S. fiscal policy is in still tinier tatters. But, unnoticed so far is the still greater danger of confused fiscal policy combined as it now is with feckless monetary policy. An economy resting on fiscal- and monetary-policy disarray is an economy at grave risk that sure-and-certain volatility will break through fragile guardrails. Strained financial systems could then quickly compound the inflationary pressures likely from Trump trade and fiscal policy along with an array of supply-chain and employment risks. And these are just the slow-burning hazards. What happens if the financial system is shocked?

Although there has long been much about Fed policymaking that strains credulity, global financial markets have looked to the Fed as to a star in the East. After 2008, markets had so much faith in the Fed that it was rightly dubbed “the only game in town” in a highly-influential 2016 book. Now, though, investors and traders are increasingly fearful that, while the game based on Fed actions is still being played with its usual ferocity, there’s no longer an umpire or safety net.

Like adolescents suddenly facing the fact that parents are far from infallible, markets have had a rude, hard awakening in 2024’s last quarter. Much has been written in recent weeks about the Fed’s steadfast assertion that it’s “data-driven” even as its decisions veer wildly from easing to tightening and back again. That a stalwart Democratic economist recently endorsed longstanding Republican calls for …

16 12, 2024

FedFin on: A Half-Empty Privatization Glass

Arezou Rafikian2024-12-17T17:52:59-05:00December 16th, 2024|The Vault|

Markets are getting very excited by ongoing Trump transition rhetoric about GSE privatization and a Friday CBO study refining its 2020 scenarios to conclude that release-and-recapitalization could proceed more quickly and prove less costly than four years ago suggested. That said, CBO remains cautious about what would happen if recap/release actually began, standing by its earlier, conservative view of budgetary implications and systemic impact. One little-noticed conclusion of note for those favoring privatization for free-market reasons: if privatized GSEs can’t sustain GSE volume, CBO concludes (we think rightly) that …

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

16 12, 2024

Karen Petrou: The Likely Banking-Agency Rewrite

Shane Smith2024-12-16T09:09:18-05:00December 16th, 2024|The Vault|

Will the Trump Administration and an agreeable Congress really make sense of U.S. bank regulation? I’m not sure that what they do will indeed make sense, but there’s so little sense in the current system that I’m confident they’ll have no qualms about vaunting the institutional barricades that have thwarted due-process reformers since a Senate Banking chair proposed to create a “Federal Banking Commission” in the early 1980s. Little in the U.S. regulatory colossus is in as much need of creative disruption as banking; the tricky bit will be to ensure that tearing down the current framework doesn’t leave it in ruins.

One reason for decades of inaction is the federalist structure of U.S. bank regulation, which allows for choice among a federal, state, or hybrid (state member) charter. Whatever is done to federal bank regulation and federal charters, there is no way Congress will even try to redesign the state-based option. It might expand preemption, but that’s as far as even this group of radicals will go because Congress will not allow each Member’s state to lose much in the federal reform many of them otherwise want.

Congress will also tread softly on one political demand: that from small banks for a regulator more likely to listen to their pleas. Right now, that’s the FDIC, which owes its supervisory role over the decades to small banks despite numerous grievous FDIC mistakes along with the agency’s tunning inability to resolve banks bigger than a bread box.

New leadership may remove …

9 12, 2024

Karen Petrou: Do We Need the Financial Stability Oversight Council?

Shane Smith2024-12-09T09:17:27-05:00December 9th, 2024|The Vault|

On Friday, the Biden Administration’s FSOC proved yet again that it deserved Rohit Chopra’s dismissive description as a “book report club.” As far as we can tell, all it has done for all of the last four years is issue some nice papers about digital assets and the payment system about which nothing was ever done and put forth dutiful annual reports along with two new systemic-designation standards with which it has since done absolutely nothing. We’ll take our usual look at this year’s annual report, but it will be even less relevant than usual because FSOC is likely to do at least as little in Trump 2.0 as it did with its own recommendations during Trump 1.0. Given this sorry record, should the Department of Government Efficiency eviscerate the Council?

Sure, why not if all FSOC plans to do is as meaningless as all is town over the past eight years. Still, Congress wasn’t wrong when it created a Council designed to force communication across super-siloed regulators and to look hard at nonbanks outside their reach. Indeed, as nonbanks increasingly dominate core intermediation and infrastructure functions, a forward-looking, effective FSOC would be a vital safeguard against market success derived principally from regulatory arbitrage.

Effective system-wide governance is not impossible. Late last month, the Bank of England showed what can and should be done to address systemic risk. Using the Bank’s authority to govern across the financial industry, it released a “System-Wide Exploratory Scenario” (SWES), essentially a financial-system wide stress …