#Fed – Federal Financial Analytics

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 …

10 03, 2025

Karen Petrou: Will Bessent Do It Better?

Eliza Allen2025-03-10T10:18:10-04:00March 10th, 2025|The Vault|

There are two ways to consolidate federal bank regulation. First, you can change the law and, as detailed in my memo a few weeks back, transform agency responsibilities to reduce duplication and regulatory arbitrage. The other way is for one federal entity to assert all the power it has under law and maybe more simply to take de facto charge of significant Fed, OCC, and FDIC supervisory and regulatory policy. Secretary Bessent has now made it clear that the Trump Administration will open Door Number Two, setting key policy goals and “coordinating” among the agencies. Will Treasury keep banking within essential guardrails? Mr. Bessent might just pull this off, at least for as long as he’s Treasury Secretary in this super-volatile Administration.

Just weeks ago, I would have said a Treasury putsch was impossible because of the Fed’s inviolable status as an independent agency that, even under a more Trump-ready vice chair, would avoid the appearance of taking Treasury’s orders less this subservience spill over to monetary policymaking. Now, though, the President has claimed via executive order that there are no more independent agencies exempt from Executive Branch control. This covers the OCC and FDIC, which were in any case sure to do what was asked of them in this Administration, but it also covers Fed supervisory and regulatory responsibilities. The Fed’s express statutory independence does not cover these activities, making it likely now that the Fed will concede on most sup-and-reg points to defend the fragile barricades surrounding monetary-policy …

24 02, 2025

Karen Petrou: How the White House Could Have Fun with the Fed

Shane Smith2025-02-24T09:11:47-05:00February 24th, 2025|The Vault|

President Trump has an awesome ability to keep even his closest allies perplexed by nonstop announcements that often break precedent, accepted norms, and even the law. Just as opponents begin to rally against one initiative, the White House launches another, sending dissenters off in a different direction, leaving the actions they initially targeted unchanged or even forgotten. Still, several policy themes are coming through loud and clear through all these different actions that have far-reaching financial-market cumulative impact. One is the sheer volatility all this chaos creates; another to which I turn here is the President’s sure and certain effort to make the Federal Reserve a tool of the executive branch, going beyond setting interest rates to turn it into America’s sovereign wealth fund.

As we noted, The President’s executive-order barrage includes one demanding a U.S. sovereign wealth fund (SWF). The tricky bit here is not the lines that would quickly blur between public and private enterprise, an historic U.S. economic principle that won’t slow Mr. Trump down for a minute. Instead, it’s where the money funding the SWF comes from given the lack of a nationalized commodities enterprise such as Norway’s and the Administration’s hell-bent campaign to reduce the federal deficit. Solution? The Fed.

U.S. law is seemingly an obstacle to deploying the Fed as an SWF since it allows the Fed to hold only direct obligations of the U.S. Treasury and its agencies as well as – a Fed sleight of hand in the 2008 crisis – Fannie …

18 02, 2025

Karen Petrou: The Fed’s Sudden GSIB Jihad

Shane Smith2025-02-18T09:06:45-05:00February 18th, 2025|The Vault|

Even as he stoutly assured Congress last week that the Fed is staunchly apolitical, Chair Powell acknowledged several post-inauguration epiphanies. These include sudden recognition of the supplementary leverage ratio’s impact on Treasury-market liquidity and the importance of cost-benefit and cumulative regulatory-impact analyses along with disavowal of all things climate risk. Another Fed U-turn relates to merger policy, but this escaped broad notice. It shouldn’t have – bank-merger policy is due for a major makeover and that matters.

In a detailed FedFin analysis of banking-industry competition last year, we looked at current market realities and years of research showing that the dramatic erosion in U.S. bank charters is not due to voracious big-bank gobbling of small-bank charters. Instead, it’s the result of inexorable technological advances combined with an array of new rules that challenge the ability of all but the very biggest banks to achieve the economies of scale and scope now vital to charter survival. Many new rules, warranted or not, have also had the inexorable effect of enabling regulatory arbitrage, empowering massive nonbank competitors who easily quash vulnerable companies unable to match technological prowess and network effects.

Sudden Fed policy reversals did not escape Republican notice, with Senate Banking Chair Scott commenting acidly about Fed “flip-flops.” But, unless Members of Congress make Jay Powell angry – and that’s hard to do in public – nothing the Fed chair says in public is offhand even if it seems that way at the time. During last week’s hearings, Mr. Powell changed …

13 01, 2025

Karen Petrou: Bowman’s Most Important Regulatory Recommendation

Eliza Allen2025-01-13T12:42:41-05:00January 13th, 2025|The Vault|

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 …

6 01, 2025

Karen Petrou: Oval Office Bluster at a Time of Fed Confusion

Shane Smith2025-01-06T09:08:37-05:00January 6th, 2025|The Vault|

There is no doubt after last year’s last-minute debacle that U.S. fiscal policy is in still tinier tatters. But, unnoticed so far is the still greater danger of confused fiscal policy combined as it now is with feckless monetary policy. An economy resting on fiscal- and monetary-policy disarray is an economy at grave risk that sure-and-certain volatility will break through fragile guardrails. Strained financial systems could then quickly compound the inflationary pressures likely from Trump trade and fiscal policy along with an array of supply-chain and employment risks. And these are just the slow-burning hazards. What happens if the financial system is shocked?

Although there has long been much about Fed policymaking that strains credulity, global financial markets have looked to the Fed as to a star in the East. After 2008, markets had so much faith in the Fed that it was rightly dubbed “the only game in town” in a highly-influential 2016 book. Now, though, investors and traders are increasingly fearful that, while the game based on Fed actions is still being played with its usual ferocity, there’s no longer an umpire or safety net.

Like adolescents suddenly facing the fact that parents are far from infallible, markets have had a rude, hard awakening in 2024’s last quarter. Much has been written in recent weeks about the Fed’s steadfast assertion that it’s “data-driven” even as its decisions veer wildly from easing to tightening and back again. That a stalwart Democratic economist recently endorsed longstanding Republican calls for …

16 12, 2024

Karen Petrou: The Likely Banking-Agency Rewrite

Shane Smith2024-12-16T09:09:18-05:00December 16th, 2024|The Vault|

Will the Trump Administration and an agreeable Congress really make sense of U.S. bank regulation? I’m not sure that what they do will indeed make sense, but there’s so little sense in the current system that I’m confident they’ll have no qualms about vaunting the institutional barricades that have thwarted due-process reformers since a Senate Banking chair proposed to create a “Federal Banking Commission” in the early 1980s. Little in the U.S. regulatory colossus is in as much need of creative disruption as banking; the tricky bit will be to ensure that tearing down the current framework doesn’t leave it in ruins.

One reason for decades of inaction is the federalist structure of U.S. bank regulation, which allows for choice among a federal, state, or hybrid (state member) charter. Whatever is done to federal bank regulation and federal charters, there is no way Congress will even try to redesign the state-based option. It might expand preemption, but that’s as far as even this group of radicals will go because Congress will not allow each Member’s state to lose much in the federal reform many of them otherwise want.

Congress will also tread softly on one political demand: that from small banks for a regulator more likely to listen to their pleas. Right now, that’s the FDIC, which owes its supervisory role over the decades to small banks despite numerous grievous FDIC mistakes along with the agency’s tunning inability to resolve banks bigger than a bread box.

New leadership may remove …

13 11, 2024

FedFin Assessment: The Fate of the Federal Reserve

Arezou Rafikian2024-11-14T15:45:31-05:00November 13th, 2024|The Vault|

In a recent client brief, we provided our forecast of what might happen to Federal Reserve independence, process, powers, and personnel under either a Harris or Trump presidency. This is of course no longer an either/or matter, with this report thus reviewing and, where needed, updating our initial assessment of what Mr. Trump could do to the central bank even where Chair Powell says he can’t. Sherrod Brown’s defeat makes the Fed particularly vulnerable in the Senate, where Elizabeth Warren (D-MA) stands a strong chance of becoming the Banking Committee’s ranking Democrat. She and incoming chair Tim Scott (R-SC) will agree on a lot about the Fed, especially if Sen. Rick Scott – a frequent Warren ally on the Fed front – becomes Majority Leader….

The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…

8 11, 2024

FedFin Assessment: Are Crypto’s Wins the Banks’ Losses?

Arezou Rafikian2024-11-08T14:57:19-05:00November 8th, 2024|The Vault|

One of the more striking results of the election is the enormous win crypto firms got for their $135 million of Congressional-campaign spending: victories so far in every race it entered. Much of this is due not just to crypto’s lure; instead, it reflects choices based not only on a candidate’s crypto sentiments, but also on the opponent’s vulnerability. As a result, at least some of crypto’s luster could fade when Congress gets back to work. However, Donald Trump campaigned on a pro-crypto platform, endorsing legislation such as the Lummis (R-WY) bill to create a “strategic reserve” for bitcoins…

The full report is available to retainer clients. To find out how you can sign up for the service, click here and here.…