#Fed – Federal Financial Analytics

3 11, 2025

Karen Petrou: How a “Finality Account” Would Make Skinny Master Accounts Make More Sense

Shane Smith2025-11-03T09:19:50-05:00November 3rd, 2025|The Vault|

As I’ve recently noted, the barrier between banking and commerce is ever more evanescent. This isn’t, though, because the banking agencies are letting legacy banks into anything redolent of commerce. It’s because the FRB, OCC, and FDIC are letting nonbanks into banking with few of the regulatory and supervisory costs demanded of existing banks big and small, with one of the most consequential one-way tickets proffered by FRB Gov Waller in his recent proposal to give eligible special-purpose banks access to the Fed’s payment system. He describes these new master accounts as “skinny,” but they have yawning pitfalls and not just for banks.

Ever since the Herstatt failure in 1974, it has been clear that payment-system hiccups give the financial system acute gastric distress. This is why central banks dominate national payment systems, with the 1980 law authorizing the Fed to do so based in large part on the Fed’s arguments that only it could be trusted to keep the payment system’s lights on. And so the Fed said again when rationalizing the need for its own instant payment system rather than entrusting technological evolution to the private sector even though the private sector led the way to real-time payments long before the Fed bestirred itself.

If it is indeed essential for the central bank to control the payment system, then access to the payment system is a public good that should only be allowed for entities able to protect the public. This is of course one of the key …

27 10, 2025

Karen Petrou: Why Scoring is Better Than Tailoring

Shane Smith2025-10-27T09:28:58-04:00October 27th, 2025|The Vault|

A friend of mine last week commented that she was a size 2 in high school, but somehow has become a size 8. If she were a bank, she’d still be forced into her size 2 jeans even if she could only pull them up over one leg and her ability to appear in public was, to say the least, impaired.

Current “tailoring” rules take no account of inflation or, even worse, much that matters when it comes to risk. In 2020, the banking agencies issued tailoring standards categorizing banks via a series of size and “complexity” thresholds that determine applicable prudential standards and supervisory vigilance, or so it was said at the time. The final rule also reserved the regulators’ right to alter a bank’s category –presumably to a tougher one – based on whatever worried them. In practice, the standards have been implemented almost exclusively by reference to a bank’s size and nothing – not even all of the risks evident at some mid-sized banks ahead of the 2023 crisis – led supervisors to look harder.

A bank below $250 billion was deemed simple and safe; any above that threshold, almost certainly not. Further, any bank above $700 billion turned into a pumpkin – that is, a GSIB – even if it is neither global nor systemically-important. Big equals bad even though bad is remarkably indifferent to asset size when there is rapid growth, ill-begotten incentives, lax supervision, or negligent risk management.

The banking agencies rightly plan to …

8 09, 2025

Karen Petrou: What Treasury Wants from the Fed and Why It Should Get it

Shane Smith2025-09-08T09:29:11-04:00September 8th, 2025|The Vault|

With all the bandwidth absorbed by the Miran and Cook dramas, insufficient attention was paid late last week to Secretary Bessent’s Wall Street Journal article laying out a new monetary-policy model. I like it a lot and not just because Mr. Bessent quotes my book. As he says, we need a different monetary policy model, one that the Fed is clearly unable to develop on its own judging by the five years of work that went into the ultra-cautious 2025 fiddles with the 2020 model. Most of what Mr. Bessent wants will make the Fed better at its core mission and a more independent guardian of the public good, overdue reforms that Democrats should support.

What does reform entail? First, the Fed would adhere to its statutory mandate, not the truncated “dual” one recent Fed leadership selects in defense of its legitimacy. Secretary Bessent and Stephen Miran read all the law, not just selected passages, correctly observing that the mandate is a triple-header of maximum employment, price stability, and “moderate long-term interest rates.” Mr. Miran’s testimony cites the 1946 Full Employment Act as one source of this mandate along with the 1978 law. Current law also implores the Fed to act in concert with the federal government to further the “general welfare.” The FRB and FOMC thus have an affirmative, express duty to do all they can to reduce economic inequality, not inadvertently but significantly worsen it as has long been the case. Mr. Bessent seconds this view …

2 09, 2025

Karen Petrou: How to Redesign the Federal Reserve Banks

Shane Smith2025-09-02T09:19:51-04:00September 2nd, 2025|The Vault|

“U.S. President Donald Trump’s radical shift in economic approach has already begun to change norms, behaviors, and institutions globally. Like a major earthquake, it has given rise to new features in the landscape and rendered many existing economic structures unusable,” or so says Adam Posen at the Peterson Institute. After last week, it looks as if the Federal Reserve as it came to be known over recent decades is also on the scrap heap. It may not be “unusable,” but the uses to which it will be put are to serve Mr. Trump’s political interests, not necessarily those also of the long-term economy’s resilience, equality, or stability. The Fed deserves this due to its geriatric monetary-policy model and persistent contributions to economic inequality. I’m not so sure about the rest of us.

The transformation already under way is not just the result of the President’s unprecedented effort to dismiss a member of the Federal Reserve Board and, if the courts rule in his favor, anyone else he doesn’t like. Another profound change could come next March, when the Board must ratify the appointments of Federal Reserve Bank presidents. With a majority of members of the Board on his side, Mr. Trump could block reappointment of all twelve Reserve Bank presidents in March of next year.

The Federal Reserve Act places a rolling list of five Reserve Bank presidents on the FOMC in an effort to balance what congress feared in 1913 would be undue Wall Street influence on monetary …

16 06, 2025

Karen Petrou: Why Republicans Want the Fed’s Money

Shane Smith2025-06-16T09:23:03-04:00June 16th, 2025|The Vault|

In the iconic movie “Goldfinger,” a murderous thug with a deadly bowler hat chases James Bond around Fort Knox as our hero stops a maniacal plutocrat from making the nation’s gold stock go radioactive. Compared to current gold conspiracies, that almost makes sense. Both President Trump and Elon Musk, among others, have doubted the security of the nation’s gold supply on nothing more than the fact that they haven’t actually seen it. To the rescue last week rode several super-conservative Members of Congress, who have introduced a bill to force an “independent” audit – read not the GAO or even Treasury – of all the gold held by or entrusted to the U.S. Gold conspiracies have come and gone since at least 1974, but the heights reached now speak to profound, widespread distrust of the government even by those who run it. This paranoia isn’t limited to inert stockpiles. It pervades two of the nation’s three branches of government and even occasionally touches the third. Thus, just because something doesn’t seem to make sense doesn’t mean it won’t happen.

I bring this up because several responses to my memo a couple of weeks back said Congress would never cotton to a sharp reduction in the payment of interest on reserve balances (IORB) or to balances held in the U.S. by foreign central banks. “Fringe thinking,” or so I was told by friends at the Fed, thinking they believed they could easily dismiss without a second thought by reminding critics …

9 06, 2025

Karen Petrou: How to Fix Regulatory Capital? Think Big, Go Simple, Get Tough

Shane Smith2025-06-09T09:32:04-04:00June 9th, 2025|The Vault|

Anyone who was surprised by Miki Bowman’s ambitious agenda hasn’t been paying attention. The new vice chair for supervision on Friday reiterated much she’s said before about supervision and regulation, now also saying more specifically what she’ll do about it given that she’s in a position to do it. Much in her plan is heartening, but one proposal is break taking in both its simplicity and importance: Ms. Bowman wants to make the complex of big-bank capital rules make sense as a whole. Former Vice Chair Barr promised to do this when he was confirmed, but he instead proposed only to complicate the capital construct. Ms. Bowman might just put it right.

As we laid out when Mr. Barr promised a “holistic” capital policy, the current approach pulls in at least three directions, and that’s before one starts thinking about unintended consequences related to liquidity and interest-rate risk. First, there are the risk-based capital (RBC) standards designed to capture the credit risk of every asset and exposure, sometimes more than once based on which numbers come out how. Not content with that much complexity, Mr. Barr and other regulators in 2023 proposed a “dual-stack” approach to credit risk largely because, we concluded, they couldn’t make up their minds which one was right. Then there are standards governing market and operational risk – some forward-looking, some retrospective, and some stuck in the middle distance.

There are also leverage rules designed to capture assets deemed to pose no credit risk even though …

19 05, 2025

Karen Petrou: The Political Buzzsaw Powering Up for the New Powell Policy Paradigm

Shane Smith2025-05-19T09:21:50-04:00May 19th, 2025|The Vault|

Buzz is growing about how the Fed’s promised new monetary-policy construct will do better than the old, failed FAIT. Last week, Chair Powell offered a teaser, the august Group of Thirty told it what to do, and former Chair Bernanke told the Fed how to tell all about it. Let’s hope the Fed indeed does better this time, but even if it does, Congress might well block the Fed from doing what it comes to think it must. When the Fed releases its new plan in the rarefied precincts of Jackson Hole this August, it’s likely to disregard what a very skeptical Congress thinks about it, let alone what might then be done to it either on the Hill or by Mr. Powell’s successor. Early warning signals show it will be a lot.

The Fed knows it’s at considerable political risk, but not all the ways political risk could strike it down. Mr. Powell is of course keenly aware that President Trump thinks he’s “Mr. Too Late, a major loser.” Anticipating still more political push-back, Mr. Powell tried to protect the Fed via a switcheroo early after the election, pulling the Fed back from climate-risk efforts and anything that smacks of reputational-risk supervision. That may help, but the Fed has yet to reckon with how much Members of Congress want a complete monetary-policy reset forcing the Fed to rely on open-market operations as the principal mechanism of monetary-policy transmission. Any new Fed policy construct that doesn’t shrink the portfolio, …

21 04, 2025

Karen Petrou: The Fed Just Puts Ribbons on Rags

Shane Smith2025-04-21T09:14:50-04:00April 21st, 2025|The Vault|

Four months after announcing plans for minimal changes to its stress tests, the Fed last Thursday screwed up its courage and proposed a couple of them. The remaining, still-small changes will come after the Fed rests up, but none of this seemingly-strenuous effort addresses the fundamental problem with both capital regulation and the testing designed to ensure it suffices: none of these rules make total sense on its own and all of them taken together are a cacophony of competing demands and ongoing collisions with other standards. Prettying up the stress-test rule is thus only putting ribbons on a ragged assemblage of ill-fitting pieces in clashing colors with large, large holes.

Now-ousted VCS Michael Barr promised a “holistic” capital construct during his 2022 confirmation hearings, but he nonetheless clung tightly to one-off rulemakings without any cumulative-impact analysis. Mr. Barr thus opposed last week’s stress-test changes, but for all the wrong reasons. He thought they went too far; in fact, they don’t go anywhere near as far as they could and should.

The new stress-test proposal most substantively says that banks will henceforth be judged by a three-year rolling average of their tested capital levels, rather than on the current, volatile annual schedule. But, averaging numbers that don’t make sense tells one nothing about the utility of each test. Think about a household with two chihuahuas – average dog weight about ten pounds. Next year, a Labrador romps in, and the average goes up, but the yard can still hold three …

14 04, 2025

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 …

17 03, 2025

Karen Petrou: A New, Unified Theory of Effective Bank Regulation

Shane Smith2025-03-17T09:13:31-04:00March 17th, 2025|The Vault|

There is one perennial, overlooked, and devastating irony in the vast body of bank capital and liquidity regulation: the better a bank’s liquidity score, the less regulatory capital it has. Although liquidity and capital are inexorably linked when it comes to preserving bank solvency, the need to comply with two contradictory standards forces banks to change their business model to meet both ends in the middle at considerable cost to profitability and long-term franchise value. This is of course a major threat to solvency of which bank regulators are either blissfully unaware or, worse, heedless. Federal banking agencies have stoutly refused to undertake the essential cumulative-impact analysis we’ve fruitlessly urged on them most recently in Congressional testimony. A new Federal Reserve Bank of New York study shows not just why they should judge rules by sum-total impact, but also how they could do so and thereby have a much better sense of which banks might actually go broke before they do.

I refer you to the full FRB-NY paper for details. It crafts an economic-capital construct calculated by netting the net present value of financeable assets versus par liabilities as a baseline measure which can then be tested under various stress scenarios that start with illiquidity and end in insolvency and vice versa. This leads to a robust measure of survivability that combines the impact of credit risk, liquidity, and the real-world market conditions current rules ignore. In essence, economic capital is derived from the hard-nosed, real-time factors that wise …