Karen Petrou: Preserving the Public Good Along with Revising Deposit-Insurance Coverage
Although HFSC’s hearing this week is cancelled due to the shut-down, there is no doubt that Congress will give careful consideration to proposals from mid-sized banks seeking a lot more deposit insurance for selected accounts. But this doesn’t mean Congress will also advance this proposal unchanged or unaccompanied. Last week’s letter from Chair Scott to Acting FDIC Chair Hill makes it clear that the Senate Banking Committee head is carefully and correctly thinking through not just which banks win or lose with FDIC-coverage changes, but also what these policies mean to the public good. In short, it’s a lot.
Sen. Scott focuses on three important questions about the second-order effects of coverage change: what might happen to depositor behavior, what rules might need to change to offset unintended consequences, and whether statutory change is needed to limit moral hazard. How FDIC coverage changes for whom drives answers to each of these questions, but several over-arching effects are clear.
First, limiting added FDIC coverage to banks based on certain asset-size thresholds ensures that banks without added protection will not roll over and cough up more insurance premiums. They’ll do what they can to avoid costs unaccompanied by benefit. The largest banks are thus likely to reduce higher-cost domestic deposits and replace them with FHLB advances, wholesale deposits, and global funding. If they substitute these for higher-cost retail and small-business deposits, as seems more than likely, then big banks are also likely to increase their reliance on short-term assets that accord with the significantly-higher duration and liquidity risk presented by this new funding model. So much for small-dollar, short-term loans, credit lines, inventory financing, and lots of other loans customers like and need.
Big banks could also use their competitive clout to remain in the retail-deposit market, reducing returns and/or increasing fees to offset higher […]
Karen Petrou: Why Stablecoins Must Also Reliably Settle and Clear
As we noted last week, a new study finds that stablecoins and other crypto payments use declined from 2022 to 2024 by about a third, now including less than two percent of U.S. households. Further, these are disproportionately unbanked, with the only bit of growth in payment-stablecoin use coming from households with poor or very poor credit scores. Payee choice was the most important driver of decisions to use a payment stablecoin. These jarring facts brings the trillions-of-trillions of dollars stablecoin dreamers back to earth with a hard thump. They might still prevail, but only if banks don’t quickly counter with potent products and nonbanks also get the rules they want and the payees they need to redefine their problematic stablecoin value proposition.
One critical battle is already being waged. Banks are fighting hard to prevent indirect payment of incentives that advantage stablecoin holders and thus undermine transaction-account alternatives. This question is among the most important on which Treasury now seeks comment before it quickly starts writing rules. The Senate Banking Committee might also revise the GENIUS Act at cost of bankers.
Despite the plethora of questions in Treasury’s recent request, another important issue is omitted: who may own a nonbank stablecoin issuer. The Act as is contains a prohibition on ownership by publicly-traded nonfinancial companies, but Treasury can waive this ban if it and other regulators reach several findings that won’t be too hard to find if Treasury wants them unearthed. Pending changes in law and rule could also significantly erode the restrictions on who may own an issuer, making the banking/commerce barrier even more porous.
As we’ve noted before, tech platform companies and large retailers have a strong incentive to persuade consumers to switch from bank deposits to stablecoins that bypass interchange fees on debit and credit cards. There’s billions […]
Karen Petrou: The Banking Lobby’s New Battlefield
Last week, a Semafor article argued that bank lobbying has lost its punch. Maybe, but before one reaches that conclusion, it’s important also to recognize that banking as an industry has also lost some of its punch while virtually every traditional business sector is bewildered day after day by the manner in which this Administration steps into markets to anoint winners and losers. Mr. Trump doesn’t much like banks, especially big ones, and this is not a problem a new PAC can solve.
Until recently, banks big and small had secure market niches and largely lobbied against each other because no one else meaningfully competed against banks. Bankers were big men (yes, they mostly were men) in each city and town and thus among each Member of Congress’ most important constituents. Due to this, smaller banks almost always beat big banks because what were then tens of thousands of small bankers were a critical presence in almost every district even though the Senate often took big banks’ side because the biggest cities had the biggest banks with the deepest pockets.
Very little lobbying was partisan because most of it was hometown-dependent, not ideological. This approach to advocacy was relatively inexpensive because banks generally relied on themselves and their trade associations, not contributions, in-house lobbyists, hired guns, PR campaigns, extensive analytics, and all the costly appurtenances of modern advocacy.
The power of incumbency once was manifest, but it has dramatically ebbed in the face of new competitors willing to spend as much as it takes in Washington to establish a firm financial-market foothold. Once these competitors were MMFs – the first to crash into banks – along with retailers, investment banks, private-equity firms, broker/dealers, finance companies, and nonbank mortgage companies. Due in part to victories at the expense of banks, many of these […]
Karen Petrou: What Treasury Wants from the Fed and Why It Should Get it
With all the bandwidth absorbed by the Miran and Cook dramas, insufficient attention was paid late last week to Secretary Bessent’s Wall Street Journal article laying out a new monetary-policy model. I like it a lot and not just because Mr. Bessent quotes my book. As he says, we need a different monetary policy model, one that the Fed is clearly unable to develop on its own judging by the five years of work that went into the ultra-cautious 2025 fiddles with the 2020 model. Most of what Mr. Bessent wants will make the Fed better at its core mission and a more independent guardian of the public good, overdue reforms that Democrats should support.
What does reform entail? First, the Fed would adhere to its statutory mandate, not the truncated “dual” one recent Fed leadership selects in defense of its legitimacy. Secretary Bessent and Stephen Miran read all the law, not just selected passages, correctly observing that the mandate is a triple-header of maximum employment, price stability, and “moderate long-term interest rates.” Mr. Miran’s testimony cites the 1946 Full Employment Act as one source of this mandate along with the 1978 law. Current law also implores the Fed to act in concert with the federal government to further the “general welfare.” The FRB and FOMC thus have an affirmative, express duty to do all they can to reduce economic inequality, not inadvertently but significantly worsen it as has long been the case. Mr. Bessent seconds this view and I know he means it. The Fed has hoped for a “wealth effect” since Chair Greenspan enunciated it, but this only made the rich richer even as it distracted the central bank from effective inflation control, the most important thing it can do to protect lower-income households.
As the […]
Karen Petrou: How to Redesign the Federal Reserve Banks
“U.S. President Donald Trump’s radical shift in economic approach has already begun to change norms, behaviors, and institutions globally. Like a major earthquake, it has given rise to new features in the landscape and rendered many existing economic structures unusable,” or so says Adam Posen at the Peterson Institute. After last week, it looks as if the Federal Reserve as it came to be known over recent decades is also on the scrap heap. It may not be “unusable,” but the uses to which it will be put are to serve Mr. Trump’s political interests, not necessarily those also of the long-term economy’s resilience, equality, or stability. The Fed deserves this due to its geriatric monetary-policy model and persistent contributions to economic inequality. I’m not so sure about the rest of us.
The transformation already under way is not just the result of the President’s unprecedented effort to dismiss a member of the Federal Reserve Board and, if the courts rule in his favor, anyone else he doesn’t like. Another profound change could come next March, when the Board must ratify the appointments of Federal Reserve Bank presidents. With a majority of members of the Board on his side, Mr. Trump could block reappointment of all twelve Reserve Bank presidents in March of next year.
The Federal Reserve Act places a rolling list of five Reserve Bank presidents on the FOMC in an effort to balance what congress feared in 1913 would be undue Wall Street influence on monetary policy if the only votes came from the Board and the Federal Reserve Bank of New York. As with the Board, the Reserve Bank system is geriatric and in long need of redesign. But, also like the Board, the President’s scorched-earth approach to reform is likely to be considerably more […]
Karen Petrou: The GSEs’ Guarantee Gauntlet
The Wall Street Journal last week described Bill Pulte’s recent mortgage-fraud allegations as ill-advised “political lawfare.” Thus it is, but it’s also an unfortunate distraction from a high-priority decision within Mr. Pulte’s legal remit: ending the GSEs’ conservatorship. If FHFA and the Administration do not tread carefully, they will do a lot of damage not just to the mortgage market, but also to the President’s mid-term hopes and long-term legacy.
The GSEs matter this much not just because a liquid, affordable mortgage market matters so much. It’s also because the GSEs issue $7.7 trillion in debt obligations, or almost a third of Treasury’s $29 trillion. The type of federal backstop afforded to the GSEs or assumed by markets determines how much Fannie and Freddie must pay to attract investors. How much the agencies pay also affects how much Treasury must pay to do the same. Because Treasury obligations float the U.S. Government’s boat, the cost of agency debt matters even more.
As we noted in a FedFin report last week, the GSEs federal guarantee comes in four flavors: explicit, “effective,” implicit, and none to speak of. Privateers refer the last flavor, but markets will assume the GSEs still enjoy an implicit guarantee no matter what anyone says, so the real flavors on offer are only the first three.
Because the GSEs are in conservatorship, they now have what FHFA has long called the “effective” guarantee – i.e., they are almost as good as full-faith-and-credit USG obligations, but not quite that good. The market thus prices in a spread of around fifteen basis points on like-kind maturities to reflect the tinge of added risk differentiating an effective guarantee from an explicit one.
This little bit of an edge may seem negligible, but it matters a lot to the U.S. Treasury, especially now […]