With the release Wednesday of the FOMC’s 2009 minutes, attention has focused on who knew what when about just how badly things were going at the height of the Great Recession. Chair Yellen was of course then the relatively lowly head of the San Francisco Reserve Bank, but she has fared very well in public commentary on her prescience and how this guides her thinking now on accommodative policy. Missed by the press are comments that are clear precursors to another critical FRB decision now in her hands: how to regulate the nation’s very largest banks. In 2009, Ms. Yellen wanted to break up big, bad banks. If she’s still feeling so unsympathetic – and I think she is – the nation’s largest banks face a serious challenge not just from shareholders demanding restructuring, but also at the FRB.
Specifically, Ms. Yellen said, “I would push these institutions [those having trouble with the 2009 stress test] into spinning off their operations, in the cases where it is needed, into a good bank–bad bank structure. I think it’s important for economic recovery.” The last point was made also in the context of being sure systemic non-banks can be shuttered, but the overall context suggests Ms. Yellen sees economic growth linked to forcing big banks into tight boxes.
Chair Yellen’s perspective is even more startling in its 2009 context. At the time, the FRB’s “SCAP” stress test – the precursor to this CCAR – was just revving up. The FRB and Treasury were principally focused not on disciplining banks, but rather on rescuing them through the authority granted in the 2008 TARP rescue legislation. That, of course, funneled billions directly into the biggest banks, as well as laying the groundwork for hundreds of billions more in indirect backstops from both the FRB and FDIC. That Ms. Yellen then wanted restructuring, not rescue, suggests strongly that comments earlier this week about streamlining the biggest banks are not just a political ploy to allay Sen. Warren and others otherwise on her side.
The 2009 comment also tells me that, when Chair Yellen talked about forcing the biggest banks to “internalize” their negative externalities during FRB action on the G-SIB surcharge, she meant it.
Thinking about Fed systemic regulatory decisions since Chair Yellen took the big seat at the top of the table, I am hard-pressed to think of a single action in which the Board did not indeed hammer hard.
Importantly, there are areas that give Chair Yellen pause. The most immediate of these is the potential impact of all of the new rules on overall market liquidity. She, along with her colleagues at the FRB and senior officials in the Treasury, are all too well aware of the near-miss during the October “flash crash.” They also know that tapering will increase market volatility even if handled more carefully than the June, 2013 near-miss. Further, the Fed’s exit strategy isn’t the only shock to which markets could fall heir – think geopolitical risk in an environmement of negative rates and be afraid.
When I spoke earlier this week to senior officers of the foreign banks doing business in the U.S., one asked me what the industry could do to explain better to regulators how dangerous some of the new rules are, especially when considered from a cumulative-impact perspective. I think Ms. Yellen’s comments reinforce the answer I gave: if banks ask for less onerous treatment for their own protection, they are sunk; if they explain why broader policy and market-integrity risks are all too real – and do so with persuasive analytics, not just rhetoric – they have a chance.