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 big banks – as earnings since massive regulatory changes have made clear, they know how to find new ways to make more than a buck even if forced out of once-key businesses. Smaller banks without economies of scale and scope are far less fortunate, as often also are consumers and even some investors.
The Great Financial Crisis of 2008 understandably led to widespread condemnation of “light-touch” bank regulation and supervision. However, the 2008 crisis would still have begun if big banks had been under tougher standards. The unwinding actually began in unregulated subprime mortgage finance and ill-regulated GSEs. Unregulated investment banks such as Lehman also took unbridled risk and, as this became clear, bank regulators tried to avert crisis first with a moral hazard-inducing rescue of Bear Stearns and then via shotgun transformations of Goldman, Morgan Stanley, and Merrill Lynch into BHCs no matter all the rules saying they weren’t eligible. The 2008 Crisis would almost surely have been cataclysmic even if pre-2008 big banks hadn’t been allowed to copy-cat the worst of their competitors despite federal deposit insurance, Fed backstops, and the faith of hundreds of millions of hapless citizens. Big banks were ill-regulated before 2008, but the fault here is that lax rules allowed them to succumb to temptation, not lead finance astray all by themselves.
The 2020 crisis was still more wholly of nonbank and regulators’ making due to run-risk and corporate-finance leverage recognized before the crash about which regulators still did nothing. Thanks in part to the 2008 rules, banks didn’t copy their competitors and proved resilient. Indeed, bank regulators eased leverage-capital standards to ensure that banks exerted a needed, market-stabilizing influence. These rules were subsequently renewed, but do they make sense?
No one knows because the “holistic” capital review Mr. Barr promised at his confirmation hearing never occurred. The Fed and its sister agencies instead rushed into a 2023 capital rulemaking said to cure what ailed that year’s failed and near-failed banks even though capital mostly had nothing to do with any of that. Several other lax rules, the Fed’s antiquated discount window, happy Home Loan Banks, and subservient supervision were at fault, but one wouldn’t know it from post-2023 agency actions and the arguments hurled from each side of the barricades not just about the proposals, but even the proposers.
Can we now have a substantive, clear-eyed discussion of what makes sense and what does not? I wish that were possible, but reasoned discourse is not a feature of our parlous times. I fear that Ms. Bowman’s most-important admonition to eschew the adversarial will be lost in the din of DOGE deregulation demands except when it comes to ending “woke” banking. All this will be as political as before, with populists and progressives continuing to use bank regulation and regulators as weapons in larger battles that obscure unintended long-term consequences along with some bone-chilling, near-term risks.