#Fed – Federal Financial Analytics

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 …

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 …