FedFin on: Why an SWF Might Solve the Conservatorship Conundrum
An intriguing op-ed in today’s Financial Times posits a solution to the GSE-privatization problem: including them in the sovereign wealth fund (SWF) already being established by the White House. Could this work? It just might.
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Karen Petrou: A New, Unified Theory of Effective Bank Regulation
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 investors and counterparties use to determine market capitalization and the cost at which banks gather funds. This is clearly preferable to the backward-looking, book-value way each bank regulatory requirement comes up with a different measure of resilience essentially irrelevant in the real world of shifting market values that can quickly […]
Karen Petrou: Will Bessent Do It Better?
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 independence. More than a few Fed Governors would even be keen to see these responsibilities move elsewhere to permit them to focus full-time on sacrosanct macro obligations.
What would Treasury-led banking standards look like? Much like Gov. Bowman’s last comments, the Secretary’s speech made it clear that he wants supervision focused on […]
Karen Petrou: The Casualties of Slash-and-Burn Regulatory Rewrites
There’s no doubt that many U.S. institutions have grown such long teeth over the years that they bit themselves in the foot. As a result, radical reform challenging conventional wisdom is long overdue. But, there are two ways to do this: the break-first/fix-later approach taken by the Trump Administration in biomedical research and other vital arenas; the other is to think first, then act decisively within the boundaries of current law or the better ones you demand. Radical reform to U.S. biomedical research is already leaving near-term treatments and cures on the cutting-room floor. If slash-and-burn transformation is also applied to financial-services supervision and regulation, systemic-risk guardrails could be unintentionally, but dangerously, dismantled.
The risks to biomedical research are not so much in what the Trump Administration has done, but that it’s more often than not done retroactively regardless of contractual commitments for continuing funding authorized under longstanding appropriations and by frenetic, indiscriminate firings of well-performing staff. You simply can’t suddenly stop a clinical trial without endangering patients and putting treatments years behind, if they continue at all. You also can’t stop basic biomedical research all of a sudden without leaving labs with a lot of mice, dogs, and primates to feed and no money for kibble. It also takes years to train good biomedical researchers; suddenly firing thousands of them endangers this pipeline and, with it, treatments and cures.
Biomedical research and financial-system governance have little in common, but leaving financial policy in tatters will also have unintended consequences with far-reaching collateral damage.
Case in point: the CFPB is among the agencies in most need of a radical makeover, but a disemboweled CFPB cannot issue the forward-looking consumer-protection standards essential not only to individual customers, but also to preventing a competitive race to the bottom with macroeconomic and systemic consequences.
If you doubt […]
Karen Petrou: How the White House Could Have Fun with the Fed
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 and Freddie obligations the Fed decided have as much of a direct guarantee as the law demands. Notably, the U.S. requirement that the central bank stays mostly virginal when it comes to other obligations that meet national objectives is the global exception, not the norm. Many central banks – see, for example, […]
FedFin on: Debanking Prohibition
In concert with other efforts to prevent debanking, two Republican senators have introduced legislation to bar insured depository institutions from certain government contracts if the IDI or its affiliate refuses to do business with lawful enterprises they dislike on what the bill describes as social-policy grounds. The bill is very brief and thus does not provide an administrative framework for implementation in areas such as determining which entities banks inappropriately dislike and which contracts are to be barred.
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