The Vault

In this report, we build on our previous analyses of the mortgage implications of the pending capital rules, forecasting what’s next for mortgage assets as the FRB, FDIC, and OCC wrestle with the mess Karen Petrou has elsewhere argued they brought upon themselves by careless analytics and political misjudgment. We think the odds for significant changes to mortgage risk weightings are high, but this won’t be enough to quell demands for a brand-new proposal….

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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 …

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” …

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 ….

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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.

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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.

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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.

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