The Vault

The Vault2023-11-21T07:33:18-05:00

Karen Petrou: The FDIC Plan to End Too-Big-to-Fail Brings Promise of More Bailouts

In 2013, the FDIC issued a short, unilluminating paper purporting to show how the agency would implement one aspect of the orderly-liquidation authority (OLA) Congress granted in 2010 to prevent the profligate bailouts that blighted the great financial crisis.  I was unconvinced by the 2013 paper and even more perplexed when years passed and the utterance on single-point-of-entry (SPOE) resolutions was all the FDIC deigned to pronounce.  After all, if big banks and systemic nonbanks can’t be closed without bailouts, then moral hazard triumphs and crashes become still more frequent and pernicious.  Last week, mountains moved and Chair Gruenberg said that anything big will not be bailed out.  Would this were true, but it’s not.

Despite the agency’s failure last year to find a solution other than a bailout for high-risk regional banks and an Inspector-General report finding the FDIC most OLA-unready, the FDIC now is confident that it can handle even the biggest blow-out at U.S. global systemically-important banks.  This derives from untested faith in SPOE, the FRB’s TLAC rule, GSIB living wills, and what it calls legal certainty pertaining to qualified financial contracts (QFCs).

Maybe so re GSIBs, but this sangfroid is still more puzzling when one reads on and finds that the FDIC thinks so well of its GSIB OLA capabilities that it says that it’s also ready to deploy them for foreign-GSIB operations in the U.S., any regional bank that hits a systemic bump, and even nonbank SIFIs.  Nothing is said about the fact that QFC contractual commitments are unlikely to work under many of these stress scenarios, some big banks prefer multiple point of entry, foreign regulators may well differ with the FDIC’s blithe assertion that they’ll support U.S. operations in their jurisdictions, and – no technicality – many potentially systemic nonbank entities do not fall […]

April 15th, 2024|

FedFin Assessment: FDIC Plan to Resolve GSIBs Fails to Answer Many Key Questions

In its first public statement since 2013 about how it would execute an SPOE resolution (see FSM Report RESOLVE23), the FDIC yesterday released a report Chair Gruenberg described as demonstrating the FDIC’s readiness to resolve a U.S. GSIB and the process it has developed for doing so under the orderly liquidation authority (OLA) provided in the Dodd-Frank Act (see FSM Report SYSTEMIC30).  As detailed in this FedFin report, the FDIC’s goal is to set stakeholder expectations regarding what to expect in an OLA resolution of a U.S. GSIB, but much reiterates current law and prior actions such as GSIB filings related to their resolution plans and the FRB’s TLAC standards (see FSM Report TLAC6)…..

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

April 11th, 2024|

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

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 about there until it was surprised to find that inflation wasn’t transitory.  It then jacked rates up at mind- and market-blowing speed starting in late 2021.  Also unsurprisingly, it turns out that rate shocks such as these also distort markets.  The Dallas Fed study takes a look at rate shocks, suggesting […]

April 8th, 2024|Tags: , , , , |

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

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 system for landmines, but also at inter-connections with telecommunications and other infrastructure providers.

The Bank of England’s recent system-wide stress test is models-based, but then that’s the bane of all stress-testing.  At least the model looks beyond the BoE’s nose.  This systemic model takes on recent events such as the gilt crisis and […]

FedFin on: Bank Merger Policy

Following its 2022 request for input, the FDIC has released a formal proposal that would redefine the agency’s bank-merger policy into one that will make it difficult for all but the smallest and simplest transactions within its jurisdiction to have the clear prospects for approval usually necessary in non-emergency transactions, subjecting other M&A applications to protracted review with a high likelihood of denial.  Strategic alliances involving nonbanks and/or nonbank affiliates and BHCs with nonbank activities may also come under critical FDIC scrutiny, complicating transactions otherwise under the FRB or OCC’s review….

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

March 27th, 2024|Tags: , |

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

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 institution even though that’s what Congress mandated over and over when it provided formidable statutory authority up to and including the orderly liquidation authority (OLA) for systemic resolutions which the FDIC’s OIG also says the agency cannot deploy.  As the FDIC itself makes clear, it wants to ban mergers at […]

March 25th, 2024|Tags: , , , , , , , , , , |
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