#Bailout

Karen Petrou: The Fed Has Given Itself Nothing But Bad Choices

Shane Smith2025-04-14T09:13:54-04:00April 14th, 2025|The Vault|

Much has been written of late about the pickle in which the Fed finds itself due to the President’s quixotic trade war. The Fed is indeed facing a dilemma setting monetary policy, but it confronts a Rubik’s Cube trying also to ensure financial stability. The reason: the more the Fed fights inflation, the less it can secure the financial system and the more it is forced to secure the financial system, the less able it will be to conduct monetary policy. This vise results from the Fed’s huge portfolio, yet another example of why the Fed should have reduced its portfolio as quickly as possible after both 2008 and 2020. Since it didn’t, it now has only bad choices if Treasury-market illiquidity turns toxic.

This negative feedback loop is the result not only of the Fed’s cumbersome trillions, but also of its unwillingness to make another hard decision: meaningful action to address identified systemic risks. Had the Fed heeded its own warnings going back to 2020, it might have done something to reduce Treasury-market dependence on high-risk, leveraged hedge funds. To be fair, the Fed cannot directly regulate hedge funds and the SEC lacks prudential authority, but both agencies had lots of ways to curtail systemic risk long before basis-trading hedge funds came to hold at least $1 trillion in assets.

So far, hedge-fund deleveraging is proceeding in a reasonably-ordered way, but risks such as these have a bad habit of cascading. Jamie Dimon already anticipates this, but he …

Karen Petrou: What the FRB and FDIC Left Out: Why They Still Can’t Shutter Regional Banks Without a Bailout

Arezou Rafikian2023-05-03T15:38:36-04:00May 1st, 2023|The Vault|

Although the Fed’s “unflinching” self-assessment of SVB’s inglorious demise and the FDIC’s still more exculpatory analysis of SBNY talk much of supervisory gaffes, neither addresses a critical unanswered question: why were both agencies so ill-prepared for such large resolutions? That they were is still more grievous when it comes to First Republic, where the agencies are flat-footed even though they’ve had over a month of warnings that FRC might not make it. As the Fed says, a banking system without failure is a financial system without intermediation. It and the FDIC clearly know that failures are inevitable, but still turn to one or another form of the taxpayer bailouts U.S. policy-makers swore after 2008 would never again disfigure the nation’s financial system. The agencies did not answer the urgent question of why even mid-sized bank resolutions are still systemic or lead to still more concentrated market power, but we must and then hold them as accountable for this failure as for all the others mentioned or not in each of their reports.

Are regional banks truly systemic or is it just that the FDIC doesn’t know what to do with them? Mass regional-bank failures are clearly problematic, but would these be likely if the FDIC knew how to resolve mid-sized banks when supervisors spot problems or, failing that as seems sadly likely, if a regional bank comes unglued? The FDIC is clearly ill-prepared to handle them even when the bank is the principal subsidiary of a non-complex BHC as is …