April 14, 2020
Early Warning: Structure of Fed Windows Will Crash Current Finreg Construct
After the rescue comes the retribution. Near-term targets abound based on early winners and losers from the Fed’s munificent rescue operations. This update names names.
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In the midst of a crisis, one minor casualty is robust political-risk forecasting. But, based on in-depth analysis to date and the blips on our early warning radar, it is already clear that the following financial-sector entities are in the red zone:
- Big Banks: This isn’t so much because they’ve done anything wrong – indeed, the largest banks have been astonishingly resilient due, as the Fed likes to say, to all of the pre-2020 rules. Even so, big banks will still get slammed because 1) they always do; 2) the differences between them and the rest of “Wall Street” are indistinguishable from both a market and political perspective; and 3) they’ve grown even more gigantic in the course of COVID, leading to still more calls to break them up and limit the monolithic control some believe they have been exerting in the course of disbursing all the Fed’s trillions and implementing the PPP.
The Fed: As a recent Karen Petrou memo noted, the Fed’s taken on tremendous fiscal and political risk just by setting up new credit-allocation and liquidity facilities. As it becomes more and more clear that high-risk sectors are profiting thereby even as small towns go begging, the Fed will face a comeuppance. It could become still stronger – that’s what happened after 2008 no matter all its failures leading up to the great financial crisis. A stronger Fed taking more financial-market control and issuing a digital currency is a real possibility, but a Fed stronger along these lines will be a Fed made far less independent. This time really is different.
Asset Management: After the smoke clears, asset managers will face a reckoning brought on by their huge draws from the Fed and Treasury no matter the protestations used to beat back post-2008 regulation – i.e., sponsors never take risks, just investors. We see new cross-sectoral capital and liquidity rules in the works along with tough new standards on funds affiliated with insured depositories.
Structured Finance: This sector beat back risk-retention rules after 2008 on grounds that – yes, investors take risk, not sponsors. Given the huge rescues embed for high-risk sectors in several Fed facilities and, even so, losses to come across the global financial system, risk retention standards are just for starters.
Mortgage Finance: Servicers are still in crisis despite Ginnie’s Monday liquidity facility and FHFA still thinks it can privatize Fannie and Freddie more or less on schedule. We think residential servicing will get a total makeover and the GSEs will be reconstructed in wholly different form post-COVID. How this happens and when depends on who’s standing where and how multifamily contagions spills over into the residential sector. Portfolio lending will be reborn, but critical sectors will still need a secondary market sure to remain but also sure to be unrecognizable in key respects.
None of these initial conclusions reflects the over-arching question of who wins the 2020 election in part because this recrafted construct will come quickly and needs only action by regulators, not legislators or the White House. November will of course redefine 2021, but it’s now a long way off and, in our view, wholly unpredictable.
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Karen Petrou’s latest column can be found here
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