#Fed – Page 3 – Federal Financial Analytics

23 09, 2024

Karen Petrou: The New Bank-Regulatory Paradigm We Need

Eliza Allen2024-09-23T11:58:35-04:00September 23rd, 2024|The Vault|

On Friday, we posted a client alert to a new Federal Reserve study that, to put it succinctly, overturns received wisdom about what makes banks fail. It is a paradigm-busting analysis based on solid, validated, empirical evidence, not on the models notoriously replete with assumptions that suit a researcher’s fancy or whomever backs the work. This study’s main finding is that, even before the advent of federal deposit insurance, bank failure is due to and reliably predicted by growing bank insolvency – not illiquidity – at otherwise-solvent banks and generally not even by runs at very weak banks. Depositors and, worse, supervisors are demonstrably slow to catch on to emerging risk, with depositors understandably subject to information asymmetries and supervisors inexcusably distracted, confused, or even captive. Policy should not be based on one study, but this one study warrants immediate attention backed as it is by many others and replete with damning data analyzed with a straightforward methodology using records going back to 1986. Now would be a very good time to take heed – banking agencies in 2024 are building yet another regulatory edifice to compensate for yet another round of critical supervisory lapses. This may well prove as doomed as its predecessors unless regulators stop blaming banks after failure for bad behavior well within supervisory sight and reach long before indisposition turned terminal.

Importantly, I am not saying that this study proves there is no need for capital or liquidity regulation just as our new merger-policy study does …

16 09, 2024

Karen Petrou: What’s Next for the Capital Rewrite

Eliza Allen2024-09-16T11:24:36-04:00September 16th, 2024|The Vault|

Few, if any, regulatory agencies are omniscient. More than a few think they are, but more often than not regulators who fail quickly to see the error of at least some of their ways are regulators who lose a lot more than they might otherwise have lost. Which brings us to the capital proposal and what next befalls this troubled standard after Michael Barr’s belated recognition that something had to give.

In the near term, we’ll see action by the FRB, FDIC, and OCC to clear a revised proposal along with the Fed’s quantitative impact survey for another round of public comment. I have to believe Fed Vice Chair Barr cleared the revisions he previewed last week with his allies at the OCC and FDIC and is confident that the Fed board will mostly agree with him up to the point of issuing a reproposal, if no further. As a result, a reproposal Mr. Barr said will amount to about 450 pages will soon be upon us.

Is this the last word? Having relearned humility the hard way, Mr. Barr promises it is not. What else might have to change to get a final U.S. version of Basel’s end-game standards across the goal line?

I would guess a lot more than would have been the case had the Fed and other tough-rule advocates more quickly recognized policy and political reality. One key, if seemingly-technical, point on which to give is the pesky “output floor.” Basel imposed the output floor because …

19 08, 2024

Karen Petrou: What the Fed Must Do to Make Monetary Policy Work

Shane Smith2024-08-19T09:22:53-04:00August 19th, 2024|The Vault|

Later this week, monetary-policy disciples – at least those who agree with the Fed – will gather around the campfire atop Jackson Hole to ponder the question set before them: whether monetary-policy transmission has been effective and, since it’s awesomely obvious it hasn’t, what might be done about that. The plan is clearly to float trial balloons in the clear mountain air to see if the Fed’s thinking about the new plan slated for 2025 is any better than that which lay behind its disastrous 2019 monetary-policy rewrite. Those allowed into these August precincts will have much of value to say this time around much as they sought to do the last time the Fed asked for all their views. Odds are, though, that Jackson Hole will not consider three non-econometric phenomena that lie behind recent policy misfires: economic inequality, NBFI migration, and the strong counter-cyclical impact of Fed supervisory policy.

Why do these matter so much?

First to economic inequality. The last time the Fed rewrote its monetary-policy model, it deigned to consider economic inequality, but promptly dismissed any reasons to worry. There were, though, lots of them.

The 2019 inequality exercise suffered from the same problem as most Fed models: reliance on representative-agent, not heterogeneous data showing distributional disparities. This approach thus reaffirmed blithe convictions that anything that keeps employment high and inflation in check is good for lower-wealth and -income households because it’s good for everyone else. See my book for why that’s grievously wrong and recent …

12 08, 2024

Karen Petrou: Why the 1951 Fed-Treasury Accord Doesn’t Matter in 2024

Eliza Allen2024-08-12T10:24:30-04:00August 12th, 2024|The Vault|

Later this month, FedFin will issue a brief assessing whether Fed independence is really at risk, taking into account not just what Donald Trump has said, but also what progressives and populists agree should be done to change the U.S. central bank’s governing law. As we’ve frequently noted, Donald Trump can talk tough about the Fed, but Congress has to agree to get tough before he can do anything but gradually change Fed leadership and hope his appointees do his bidding despite formidable resistance across the Fed’s entrenched institutional culture. The forthcoming brief will put much of the daily back-and-forth on this critical question into the often-missing context needed to understand how much risk the Fed really runs. However, I’ve gotten so many questions in the last few days following an American Banker article that I’ll answer a few of them now.

The questions revolve around the Fed-Treasury agreement in 1951 putting Treasury fully in the debt-pricing lane and keeping it out of Fed decisions setting monetary policy based on its macroeconomic judgment, not national fiscal or political demands. The question? It’s whether Treasury under Trump could revoke the 1951 Accord and regain control over monetary policy.

The best independent analysis of the history surrounding the 1951 Accord and its substance comes in a paper written in 2001 on the Accord’s fiftieth anniversary by staff at the Federal Reserve Bank of Richmond. It rightly puts the Accord squarely in the historical context necessary to understand if the 1951 Accord has …

3 06, 2024

FedFin on: Discount-Window Modernization

Arezou Rafikian2024-06-03T17:00:38-04:00June 3rd, 2024|The Vault|

In addition to controversial provisions affecting bank-merger applications and stress-test transparency, legislation recently approved by the House Financial Services Committee includes a less-contentious provision forcing the Federal Reserve to reckon with longstanding problems affecting the use of its discount window, especially under stress conditions. These problems were on costly evidence in March of 2023, when both Silicon Valley Bank and Signature Bank had extraordinary difficulty accessing the discount window due in part to ill-segregated collateral and early Fedwire closing….

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

22 04, 2024

FedFin on: Fed Systemic-Risk Assessment: Some Worries, No Troubles

Eliza Allen2024-04-23T16:37:21-04:00April 22nd, 2024|The Vault|

The latest Federal Reserve financial-stability assessment continues the Fed’s practice of detailing vulnerabilities without drawing bottom-line conclusions; the Board once did so, but ceased this practice after opining that the financial system’s risk was “moderate” shortly before the 2020 crash. The Board’s report now also says that it assesses vulnerabilities, not the likelihood of near-term shock. Survey respondents do make this assessment, with this report showing a striking increase in concerns about policy uncertainty in light of continuing inflation and the higher-for-longer rate outlook…

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

8 04, 2024

Karen Petrou: Why Lowering Interest Rates Now Makes Housing Even More Unaffordable

Shane Smith2024-04-08T09:30:15-04:00April 8th, 2024|The Vault|

As we’ve noted, Sen. Warren and a raft of progressive Democrats are emphatically demanding that the Federal Reserve lower interest rates to promote affordable housing. However, as a new Federal Reserve Bank of Dallas note confirms, low rates don’t necessarily make it easier to buy a home because house prices generally rise as rates fall. Worse still, ultra-low real rates eviscerate not just the ability of all but the well-heeled and -housed to save for a down payment, but also for much else that ensures economic resilience and long-term security. Simply put, lower for longer makes the U.S. still more economically unequal, not exactly what progressives want.

The assumption in Sen. Warren’s letter and a like-kind one from Chair Brown is that lower mortgage rates reduce the carrying cost of a mortgage and thus make it easier for lower-income households to qualify for a loan. However, this seemingly-obvious conclusion assumes that housing markets are static and, as any real-estate agent will tell you, they aren’t.

When rates go down, demand goes up and prices do the same. Or, as the Dallas Fed study observes, a one-percentage-point hike in short-term rates usually lowers house prices by 7.5 percent over two years. Just as intuition suggests that easy money spurs homebuying, so it is that tight money reduces demand and prices respond accordingly.

Or, they do in a normal market and there haven’t been any of these since the Fed sent interest rates below inflation-adjusted zero in 2008 and kept them …

1 04, 2024

Karen Petrou: The Frightening Similarity Between Key Bridge and Bank Stress Tests

Eliza Allen2024-04-12T09:41:28-04:00April 1st, 2024|The Vault|

On Friday, the Washington Post reported that Key Bridge passed all its stress tests before it fell into the harbor. These were well-established protocols looking at structural resilience – acceptable, if not awesome – and, after 9/11, also at terrorist attack. That a giant container ship might plow into the bridge was not contemplated even though this has happened before in the U.S. and not that long ago. Which brings me to bank stress-testing and how unlikely it is to matter under actual, acute stress because the current U.S. methodology correlates risk across big banks in ways that can make bad a lot worse. Even more troubling, tests still don’t look over the banking parapet.

To be sure, the Fed’s semi-annual financial-stability reports (see Client Report SYSTEMIC97) muse about risks that lurk outside the largest banks, and FSOC dutifully catalogs nonbank risk each and every year in a copious annual report (see Client Report FSOC29). Last year, FSOC also said a lot about what might someday be done to address it via systemic designation (see FSM Report SIFI36). But what’s being done, not just said, about nonbank risk even as inter-connections become ever more entwined? Not much in the U.S. even though other national regulators are taking meaningful steps first to know where it lies and then to curtail it.

For example, the Bank of England and Australia’s Prudential Regulatory Authority are quickly moving past bank-centric stress testing, with Australia importantly looking not just within the financial …

25 03, 2024

Karen Petrou: How the FDIC Fails and Why It Matters So Much

Eliza Allen2024-03-25T11:45:45-04:00March 25th, 2024|The Vault|

Last January, we sent a forecast of likely regulatory action and what I called a “philosophical reflection” on the contradiction between the sum total of rules premised on unstoppable taxpayer rescues and U.S. policy that no bank be too big to fail. Much in our forecast is now coming into public view due to Chair Powell and Vice Chair Barr; more on that to come, but these rules like the proposals are still premised on big-bank blow-outs. I thus turn here from the philosophical to the pragmatic when it comes to bank resolution, picking up on a stunning admission in the FDIC’s proposed merger policy to ponder what’s really next for U.S. banks regardless of what any of the agencies say will result from all the new rules.

Let me quote at some length from the FDIC’s proposed merger policy:

“In particular, the failure of a large IDI could present greater challenges to the FDIC’s resolution and receivership functions, and could present a broader financial stability threat. For various reasons, including their size, sources of funding, and other organizational complexities, the resolution of large IDIs can present significant risk to the Deposit Insurance Fund (DIF), as well as material operational risk for the FDIC. In addition, as a practical matter, the size of an IDI may limit the resolution options available to the FDIC in the event of failure.”

In short, the FDIC wants to block most big-bank mergers because it can’t ensure orderly resolution of a large insured depository …

5 02, 2024

Karen Petrou: Why Lower Rates Won’t Lead to More Affordable Housing

Shane Smith2024-04-12T10:31:58-04:00February 5th, 2024|The Vault|

As Politico rightly pointed out last week, the inability of anyone who doesn’t already own a home to get one is turning into a significant political problem for incumbents of all persuasions. It might also come to be one for the Federal Reserve based on a call I got from a senior senator a couple of weeks ago. This is not exactly what the Fed needs given how hot a political potato it’s already become.

Having read my economic-inequality book, the senator called to ask if I thought the Fed had any responsibility for the acute shortage of affordable housing. As in all too many other states, his has seen a migration of teachers, first responders, and the middle class as a whole from cities and resort areas, with these vital workers forced to live hours from their jobs and thus in a state of perpetual commuting which they fear puts their children at risk.

This isn’t news, but it’s worse than ever and thus not just a daily grind for many Americans, but also a serious political threat to this moderate Democrat. His state is deep purple and he believes it’s getting redder by the minute thanks to Donald Trump’s ability to mobilize voter anger on day-to-day economic challenges such as the critical one facing those who cannot find affordable, desirable housing within reasonable distance of their jobs.

As might be expected, the senator wasn’t calling to ask an academic question; he wanted to know not just …