Karen Petrou: Making Liquidity Regulation Make Sense
Although U.S. regulators remain determined to enact each rule as if it relates to no other, researchers have increasingly found that rules have cumulative and often conflicting purposes – see, for example, the sum total of bank rules which empowered nonbank financial intermediaries operating with impunity until they needed trillions in taxpayer backstops in 2020. Following a seminal Federal Reserve Bank of New York paper on the cumulative consequences – none good – of considering capital and liquidity rules in isolation, a new BIS paper considers the internal contradictions of consequential liquidity regulation and central-bank backstops. Now, if only bank regulators at home and abroad did the same.
The BIS paper looks at the push-pull evident in liquidity rules founded on expectations that banks should not use central-bank liquidity even though central banking is founded on the concept of providing liquidity to banks under stress. As all too evident in the 2023 crisis, liquidity compliance cannot ensure banks stand firm in a run, even as the Fed’s discount window opened with all the alacrity of an centuries-old casement. Solutions posed ever since have suggested stiffening the liquidity standards and ensuring discount-window operability, but each thread of this debate ignores the other. The BIS paper happily proposes a framework in which the two pillars of bank resilience under liquidity stress are considered together to craft a sensible benign-scenario liquidity rule along with an effective, disciplined backstop that minimizes moral hazard.
The BIS paper rightly is to avoid so stringent a build-up of liquidity that it drains capital resources and bank lending dries up. The fundamental idea behind global and U.S. liquidity regulation is that banks must hold “high-quality liquid assets” (HQLAs) that can be readily liquidated under even acute stress to give banks the cash needed to handle a run or fire sale. […]
FedFin: Could It Be?
Yes, it could, but still… The President’s post yesterday turned the tables on those – ourselves very much included – who had been told by key officials that GSE privatization was a low-order priority at a time of so much macroeconomic and political turmoil. But, the President seems to thrive on turmoil and it’s thus the GSEs time to get the treatment. How might the Administration go about capturing all the GSE revenue on which the President has his eye? It’s there to be gotten, but the getting is complicated…..
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Karen Petrou: The Political Buzzsaw Powering Up for the New Powell Policy Paradigm
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, continues to rely on interest on reserve balances (IORB), preserves the Overnight Reverse-Repo Program (ONRRP), or eases up on inflation targeting will get a very, very rough reception.
Last week brought two sharp reminders that key Members of Congress contemplate wholesale, structural change in Fed monetary-policy operations. Some aspects […]
Karen Petrou: Why Stablecoin Hegemony Could Cost Too Much
In the battle over stablecoin regulation, defenders of the pending legislation make much of the need for the U.S. to become the dominant global leader. That’s fine, but what if the new stablecoin framework gives the U.S. crypto preeminence at the cost of U.S. bank resilience and macroeconomic growth? That would be a high price to pay, but it’s nonetheless the Faustian bargain lurking in the latest legislation.
As our analyses have made clear, the House and Senate bills address only payment stablecoins – i.e., digital assets used by consumers and companies to settle financial accounts or to purchase goods and services. The idea is to make regulated stablecoins as reliable a medium of exchange as dollars, with the bills’ reserve-asset requirements meant to ensure that one stablecoin dollar always equals one U.S. dollar. This is fine as far as it goes, but that’s not far enough to ensure payment-system finality, ubiquity, and equality. A more robust stablecoin also does little but make it still more likely that regulated banks will be disintermediated as deposits move from the current, fractional system into a new, “narrow bank” model that does little for anyone but stablecoin issuers, their affiliates, and parent companies such as giant tech platforms.
A dollar’s worth of stablecoins is little more than an abstraction until one knows how it moves across the payment system. If the payment rails are weak or the engineer is negligent, then armored boxcars just make an even bigger, harder bang when they derail.
Payment stablecoin issuers know this even though Congress has resolutely sought to stay out of the bitter battle between bank and nonbank issuers over access to the Fed’s payment system via master accounts. If nonbank stablecoins get a ticket to ride the Fed’s payment rails, then they will in theory be as […]
Karen Petrou: Why Ratings Are Late Matters a Lot
The Wall Street Journal on Friday speculated that CAMELS ratings for the biggest banks are delayed due to looming change in the Board’s supervisory philosophy after Gov. Bowman is confirmed. Or, the Journal speculates, perhaps specific examiner ratings are being overridden by senior officials outside the examination chain of commands. There’s no question that supervisory ratings are on hold, but the reason for the delay will reveal the difference between a supervisory framework with integrity and one craven to political whim.
As I’ve written, the bank-supervisory system needs radical overhaul at the FRB and FDIC and could do with more than a touch-up at the OCC. The Fed’s own report on SVB and the FDIC’s assessment of Signature show flaws from top to bottom that are virtually-identical repeats of flaws that led to the 2008 crisis. The Fed and FDIC promised big fixes, but none has been made public and some appear quixotic.
Gov. Bowman is thus right to question the way the Fed supervises and rates banks. Fed examiners rated SVB’s risk-management exposures and capabilities well until right before the bank’s imminent demise suggested a downgrade. This follows a pattern all too reminiscent also of credit rating agencies: everything’s A-OK until market forces turn inexorable because investors are far better attuned to risk than examiners. See again why I think that economic-capital measures of capital are a better way to ensure resilience under stress.
Also right are those calling for a radical rewrite of the management test behind CAMELS’ “M.” M has been judged too often with kid gloves – see recent failures – or political objectives.
One way to ensure examination-ratings integrity is transparency and accountability – see also my calls for retrospective disclosures. Examiners held accountable for errant ratings only after bank failures are of course examiners faulted far too […]
Karen Petrou: What Else Should Worry You
Last week, the Washington Post ran an astonishing article, easily overlooked in the personal-finance section. In it, the writer advised the many consumers she said were besieging her with fearful questions about how best to ensure their money is safe in the bank – and, if they’re still worried, where to buy a nice safe. That same day, a friend asked me if his short-term Treasury bills are safe. These are, of course, anecdotal reports, but such worries are rarely tracked as the leading indicators they are. It’s obvious in crisis after crisis that, when retail depositors and investors are frightened, we should all be very worried.
How much uncertainty does it take to create a financial or macroeconomic crisis? None of the Fed’s financial-stability reports deigns to consider consumers, nor does the Fed tell us when to worry because it fears we will if the Fed cracks its stone face. However, a brand-new Fed study provides a very useful – if frightening – analytical context in which to consider anecdotal data.
The Fed staff paper examines different types of uncertainty and their impact on economic activity and financial conditions. While it doesn’t directly extend the analysis to financial stability, the results are important given the strong correlation between economic and financial volatility and very, very bad financial-market events.
The paper assesses six key drivers of uncertainty: real economic conditions, inflation, economic policy, trade policy, geopolitical risk, and financial uncertainty as reflected in the VIX. These uncertainty drivers exploded by four to sixteen standard deviations based on the indicators from 2019 to 2024. Notably, economic and financial uncertainties had the biggest macro impact and God knows how many standard deviations we are now from the already-worrisome end-2024 indicators.
And, even these aren’t as bad as they might be – none of these […]