The Vault

FedFin’s in-depth analysis of the Basel Committee’s cryptoasset proposal kicked up quite a fuss. The major point of contention is our conclusion that the new approach might recast crypto in favor of regulated banks. Some said instead that the new capital requirements are punitive to the point of prohibitive. However, a close read of the consultation persuades me that, despite the need for refinements in several critical places, crypto counterparties outside the lure of illicit finance or high-flying speculation will prefer doing business with a bank and that the new rules make it possible for banks to do business with them. After all, each of us can always give our money to any person or business to hold for us; we instead deposit our money in the bank because, thanks in good part to FDIC insurance and the rules it requires, we know we’ll get our money back.

Stripped to its capital essentials, the consultation creates two classes (inexplicably called groups) of crypto assets. Those which are tokenized versions of other assets – e.g., fiat currency, a mortgage loan – come under risk-based and leverage capital rules largely comparable to those now applied to the underlying asset. Although there are additional risk-management considerations, the difference between a tokenized-digital and a “real” asset is likely a capital and liquidity wash.

Digital assets more like stablecoins get similar like-kind capital treatment, but tough standards also apply to ensure that the underlying real asset is always there and always worth what the digital representation would lead one to expect. This requirement could put bank-issued stable-assets at a disadvantage to other issuers – e.g., Facebook’s Diem – that need not adhere to rigorous capital or reserving or have balance sheets big enough to bear it.

But, unless these nonbanks also have access to the payment system – […]

As detailed in our new in-depth report, the Basel Committee is proposing a new regulatory framework for bank exposures to cryptoassets that will influence not only what banks do in this critical arena, but also what the GSEs can do and thus what happens to the digital mortgage.  If Fannie and Freddie come under like-kind capital and liquidity rules related to their crypto exposures, digital adoption of any asset with crypto components will be slower but the system could well be safer.

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

Pressure builds for Fed chief as inflation surges
By Sylvan Lane

The Federal Reserve is facing growing scrutiny from Wall Street and Washington over its cryptic plans to eventually pull back stimulus from an economy that’s starting to struggle with inflation. Fed watchers are eagerly seeking clarity from Chairman Jerome Powell about when the central bank aims to pare down the monthly purchases of bonds meant to dampen the economic blow of COVID-19…And other critics of the Fed’s approach say allowing near-zero interest rates and steady bond purchases to add further fuel to soaring stock prices will only deepen historically high economic inequality. While easy monetary conditions are intended to fuel job creation and economic activity, they can also encourage more speculative forms of investment since low interest rates lead to little growth for savers. “The new policy has been unintentionally but powerfully unequal, and a spike in inflation will be very powerfully anti-equality,” said Karen Shaw Petrou, author of “Engine of Inequality: The Fed and the Future of Wealth in America.” “It’s continued increase in its portfolio combined with rates that are negative in inflation-adjusted terms just drives not only a tremendous amount of wealth inequality, but also distortions in productivity.”

https://thehill.com/policy/finance/558405-pressure-builds-for-fed-chief-as-inflation-surges?rl=1

Advancing some of the most controversial ideas in a 2019 discussion paper,  the Basel Committee has now formally proposed capital, liquidity, risk-management, and supervisory standards it believes nations should apply to bank cryptoasset exposures.  Global regulators have adopted a cautious approach that, despite high-cost proposals for higher-risk cryptoassets, may create a framework in which banks can profitably engage in a wide array of cryptoasset activities and thus expand cryptoassets with the stability and liquidity essential for many of the uses now proposed for them.

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

Although it seems technical, the question of what’s a qualified mortgage (QM) defines which mortgages make up most of the U.S. market.  This, though, is well known after years of QM squabbles.  What many have forgotten is an even bigger question:  what’s a qualified residential mortgage (QRM).  This term defines which mortgages can be securitized without forcing the originator to hold “skin in the game” – i.e., a portion of the loan on its portfolio.  Given the transformation of U.S. mortgage finance into a business dominated by nonbanks without balance sheets, a problematic QRM would quash a whole lot of mortgage finance no matter the QM.

The banking agencies, SEC, FHFA, and HUD finalized the QRM in 2014 after two proposals and a whole lot of controversy.  The problem crafting the QRM was the wide divide between MBS investors – who wanted tough credit-risk retention to ensure incentive alignment – and lenders who wanted none of this.  Policy-makers were split, but the balance ultimately came down in favor of the current QRM because of concerns so soon after the great financial crisis that housing finance couldn’t recover without a free pass to the secondary market.  Private-label securitizers pushed for equal treatment with the GSEs if private credit enhancements or other capital stood ahead of the investor in a QRM, but the reputation of private mortgage insurance (MI) was badly sullied by the crisis and there was little faith in PLS or their ratings after the subprime-MBS debacle.  As a result, the final rule said that QRMs were any loan that was also a QM and, given that the QM then applied to any loan sold to the GSEs and FHA, the mortgage market quickly turned into QMs sold almost exclusively through taxpayer-backed channels.

However, this was a roughly-hewn compromise many […]

Everything’s coming up inclusive these days.  Indeed, any policy anyone wants to pass is inevitably dubbed inclusive just as any pair of jeans is said to be slimming.  However, genuine inclusion isn’t any easier than a fashion silhouette.  Thus, to understand which inclusiveness claims are compelling and thus which policies warrant pursuit, one has to look past the label to see if it really fits.

As just one example – policies on CBDC and the payment system – makes clear, any judgment about inclusion must start with an understanding of who’s being included into what on which terms.  Just because something is ubiquitous – a major rationale for both CBDC and Fed ownership of the payment system – doesn’t mean it’s inclusive.  Think for example about check-cashing stores or payday lenders – they’re often ubiquitous in the areas seen most as in need of inclusion, but this ubiquity of course comes at a high cost to economic equality by virtue of the price demanded for these financial services.

Ubiquity is anti-inclusive if it comes at cost to those using a service, those with an idea for a competing and better service, or those for whom the seemingly-ubiquitous offering is inaccessible due to barriers erected by income, age, or ability.  That something is present for most people and even cost-effective for them still doesn’t mean it’s ubiquitous unless it’s also right for the most vulnerable and present for those who need it most.

Indeed, ubiquity can be achieved at considerable cost to equity.  Facebook, Amazon, and other tech-platform firms are ubiquitous and even inclusive in that at least some of them have made efforts to enhance accessibility to those for whom digital access is problematic.  They are also way, way inclusive measured by price because access is free – one needs no ticket to […]