Fed Stability Report Incomplete (December 5)

Update 316 — Fed Stability Report: Incomplete
Missing: Systemic Risk and TBTF Analysis

Yesterday, the Dow lost over 800 points, its third worst point decline in history; the S&P 500 saw its steepest fall since February. Waves of selling are hitting Wall Street amid fear of slowing economic growth and trade tensions between the U.S. and China.  The VIX — Wall Street’s fear gauge — is on the rise again and hasn’t fallen below the 15 point benchmark for market stability since September.

Not the picture of financial stability. This of course was not reflected in the Federal Reserve’s Report on Financial Stability yesterday.  But neither was analysis conducted or even reference made to TBTF and systemic risk in the financial sector, oddly. There’s a curious Nothingburger here.  Details below…

Best,

Dana

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Last week, the Federal Reserve released its first Financial Stability Report, a new semi-annual publication that will provide an overview of the health of the financial system.  Missing from this overview is a thorough discussion of regulatory rules and their impact on systemic risk — a curious oversight given that the Fed announced its plans to reduce capital and liquidity standards for banks between $100 and $700 billion in assets just last month.  These changes will increase systemic risk and instability in the financial system. The Fed’s report concludes that big bank capital and liquidity is adequate, but ignores the systemic risk implications of its current rulemaking proposals and market forces, such as debt levels and increasing consolidation in the sector.

The Fed’s First Financial Stability Report

The Fed’s new semi-annual report complements the existing annual report by the Financial Stability Oversight Council (FSOC) and is similar to others produced by central banks around the world. The Fed has lagged behind other countries in terms of transparency, so this report is a welcome step in aligning to global norms. Fed Governor Lael Brainard calls it “an important step in providing the public with more information about the board’s assessment of financial stability.”

The report was generally positive; the labor market is strong, inflation appears to be controlled, and wages are growing moderately. The report did, however, identify four broad categories of vulnerability in the financial system:

  • Elevated valuation pressures: Echoing Brainard’s warning in a speech earlier this year, the Fed is concerned that elevated asset prices are signalling an increased willingness of investors to take on risk. Greater appetite for risk implies a greater possibility of outsize drops in asset prices, or losses, that could shock the financial system. This risk has been made clear by the recent volatility in the U.S. stock market.

  • Excessive borrowing by businesses and households: Historically, heightened borrowing by businesses and households has resulted in major stress on consumers, as well as the financial system. After a steady rise at pace with nominal GDP, business and household borrowing is starting to grow at a faster rate. Business debt levels in particular are high, with signs of increased risky debt issuance and deteriorating credit standards. Although household debt is concentrated among low-credit-risk borrowers, households are still struggling with student, auto, and credit card loans.

  • Excessive leverage within the business sector: The leveraged loans market is worth just over $1 trillion, and in its report, the Fed highlighted this market as another cause for concern. Current regulators have rolled back the leveraged loan safeguards put in place by Obama-era regulators. Investors have flocked to this market, and leveraged loan prices will likely deteriorate rapidly in the event of a crisis. Leveraged loan funds have already seen heavy outflows in recent months.

  • Funding risk: Many firms have taken advantage of the period of record-low interest rates after the financial crisis by taking on mountains of debt. Both the Fed and the Office of the Comptroller of the Currency (OCC) have expressed concern about the high level of corporate debt. Per the report, corporate borrowing levels are “historically high” and debt at US nonfinancial companies is up nearly 70 percent since 2008. Ominously, debt levels at nonfinancial companies have typically risen sharply just before the past three downturns.

If It Ain’t Broke, Don’t Unfix It

The report concluded that “the nation’s largest banks are strongly capitalized” and “hold more liquid assets” than in the period leading up to the crisis, making them more resilient in case of another downturn. Despite the relatively rosy tone taken by the Fed on the state of the financial sector, it continues to plug away with the deregulatory agenda meant to roll back “burdensome” Dodd Frank-era rules.

Last week, the Fed released an official rule report outlining a number of changes that were first presented by Vice Chair Quarles about a month ago. The rule report is a detailed overview of how the Fed plans to implement S. 2155 and “tailor” regulatory processes. These proposed changes include:

  • raising the asset thresholds for banks to be subject to enhanced prudential standards

  • overhauling the Dodd-Frank stress testing framework

These changes are likely to increase systemic risk and harm the stability of the financial system. Find a more detailed explanation of our views on the proposed changes here.

Monetarist Approach to Systemic Risk

When it comes to monetary policy, the Fed is on cruise control. The Board has raised the short term interest rate eight times since 2015, the last time in September from 2 to 2.25 percent, as part of the Fed’s dual-mandate to achieve full employment and sustainable inflation rates. Given those narrow objectives, the Fed has done a commendable job, but is it doing the right things to protect those gains in the future?

While mainstream media seems enamoured with last-minute changes to the interest rate, they fail to see what the Fed is doing when it comes to regulation and oversight, which may have more impact on the economy in the long-run. Vice Chair Quarles is pushing rule changes to capital regimes at a time when risk in the economy is low, but continued growth is uncertain.

Conclusion

The current Fed is on a mission, seeking to reduce capital and regulatory standards at precisely the most counter-cyclical time. Coming to the end of a long period of growth and stability, we need the safeguards implemented by Dodd-Frank. Reducing regulatory requirements at this juncture facilities risk-taking by financial institutions as the economy slows, setting up a repeat of 2008 as institutions chase returns that will be increasingly diminished.

In a speech at the Economic Club of New York on Wednesday, November 28, Powell said: “The question for financial stability is whether elevated business bankruptcies and outsized losses would risk undermining the ability of the financial system to perform its critical functions on behalf of households and businesses.” Powell contended, as his predecessors did in the run-up to 2008, that such losses would likely fall on investors rather than posing a threat to the financial institutions that are at the core of the system.

If history has taught us anything, it is that average Americans are always the ones who bear the brunt of financial crises, not wealthy investors.  During his speech last week, Fed Chair Powell asserted that monetary policy should not be used as a tool for stabilizing a financial crisis, yet he appears content in allowing the Fed to pursue destabilizing rule changes in financial policy.

 

Maxine Takes Helm at House Financial Svcs. (November 30)

Update 315:  Rough Waters Ahead for Banks?
Maxine Takes Helm at House Financial Svcs.  

The gavel passing from retiring Rep. Jeb Hensarling (R-TX) to Rep. Maxine Waters (CA) at the House Financial Services Committee augurs one of the clearest sea changes in policy and style a U.S. House Committee will see in the 116th Congress.  

Accordingly, we have a closer look today at what these changes under Waters imply regarding  particular policy priorities among the legislative agenda and issues before the Committee.

Good weekends, all…

Best,

Dana

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The Immovable Waters

Rep. Waters’ bedrock issues have long been housing, consumer protection, and big bank regulation. In the 115th Congress, Waters focused on protecting the Community Reinvestment Act, designed to prevent discriminatory credit practices, and guarantee fair housing protections.

A number of bills introduced by Waters during the current Congress (capping a six-year tenure as Ranking Member of HFSC) indicate her key priorities, including:

 

  • Public Housing Tenant Protection and Reinvestment Act of 2017 — H.R. 3160: The bill reforms the public housing demolition and disposition rules to require one-for-one replacement and tenant protections, and provides public housing agencies with additional resources and flexibility to preserve public housing.

 

 

  • Comprehensive Consumer Credit Reporting Reform Act of 2017 — H.R. 3755: The bill enhances requirements on consumer reporting agencies, like Equifax, TransUnion, and Experian, to better ensure that the information on credit reports is accurate and complete.

 

  • Megabank Accountability and Consequences Act — H.R.3937: The bill would give authority to federal banking regulators to break up banks that mistreat their customers.
  • Consumers First ActH.R.6972: The bill would reverse the harmful changes to the Consumer Financial Protection Bureau imposed by the Trump Administration and restore the agency’s supervisory and enforcement powers.

  • Restoring Fair Housing Protections Eliminated by HUD Act of 2018H.R.6220 The bill would restore several fair housing protections that HUD Sec. Ben Carson eliminated.

Blue-Moon Bipartisanship?

During her tenure as Ranking Member on the Committee, Rep. Waters supported bipartisan legislation, notably the third iteration of the JOBS and Investor Confidence Act (aka JOBS 3.0; see our take on that package here). The bill includes provisions aimed at “decreasing the regulatory burden” for some financial institutions, as well as others that aim to increase protections for consumers.

In a similar vein, she partnered with Sen. Sherrod Brown on S. 1491, the Community Lender Regulatory Relief and Consumer Protection Act of 2015. The bill would give banks and credit unions with under $10 billion in assets relief from the Consumer Financial Protection Bureau’s (CFPB) “Qualified Mortgage” rule.

Appealing to Waters’ passion for housing reform, the measure would make permanent expired provisions that protect tenants from eviction when their landlord or property owner has entered foreclosure. When it comes to her bedrock issues, Waters may be more willing to compromise to ensure she reaches her legislative goals.

She has also reached across the aisle to work with Republicans to reauthorize the Export-Import Bank, and used her political savvy to get Republicans on board with a reauthorization of the National Flood Insurance Program. While she will look to make some strides in these areas as Financial Services Chair, she has expressed firm and progressive stances regarding systemic risk and oversight.

Mitigating Systemic Risk

Importantly, Rep. Waters at the helm of the HFSC means two things for systemic risk:

  • the “tide” of financial sector deregulatory passing the Committee is “at an end”
  • regulators and agencies should be prepared to will have their feet held to the fire more often

Heading into the next Congress, a key item on Waters’ agenda will be monitoring systemic and other risks in big banks. The financial industry has enjoyed several months of continuous deregulatory activity under an HFSC headed by Rep. Hensarling and a Republican-controlled Congress. Under her leadership, the Committee will be limited in its ability to stall measures at the federal regulator level, but it will be able to increase oversight and change rhetoric to keep a check on agency overreach.

In the words of Waters, “as we saw in the last crisis, it is the average hard-working Americans that will suffer the consequences if Washington deregulates Wall Street megabanks again.”

Oversight in Her Sights

A robust oversight agenda will accompany the legislative priorities of the Committee under Waters. This agenda will likely focus on four distinct areas: firms, rulemaking, agencies, and the presidency.

On the firms, Waters has expressed indignation about the slap-on-the-wrist treatment of Wells Fargo in light of the improper and unfair foreclosures on its customers. Many were erroneously denied loan modifications to lower their mortgage payments.

A Democrat-controlled House cannot do much in the way of affirmative rulemaking, but it will no longer have to play defense against further attempts at deregulation. Much of Waters’ oversight in this area will be over agencies, ensuring that the Trump appointee-controlled CFPB, FSOC, and OFR are operating according to their original statutory purposes and with the resources they need. This will likely take the form of hearings, subpoenas, and investigations.

Waters has been steadfast in her position that investigation into the president’s alleged illegal financial dealings is on her agenda, but it’s not her top priority. In a Bloomberg interview earlier this month, Rep. Waters was clear that she would use her authority to get more information, using subpoenas if necessary, but was far more eager to discuss Wells Fargo and the CFPB.

An Able Veteran who Came to Legislate

Waters is a skilled and seasoned legislator. Her turn with the gavel at HFSC is very welcome news and signals the end of the tide of deregulation. It also signals an end to a period of free-reign for regulators (or should we say deregulators) dogmatically pursuing an agenda that puts Wall Street megabanks ahead of ordinary Americans. Her agenda will be limited by the Republican-controlled Senate, but it will set the tone and pave the way for future legislation that will curb the rollbacks of Dodd-Frank that have occured in recent years.

 

Economic Policy Implications of the Midterms (November 13)

Update 312:  Economic Policy Implications
of the Midterms and the 116th Congress

The result of last week’s midterms will have important ramifications for economic policy during the 116th Congress.  Democrats have taken the majority in the House and will take majority control of key committees setting the legislative agenda.

More than 100 women were projected to win seats in the House of Representatives, easily shattering the record of 84.  Overwhelmingly, they were Democrats, including 30 candidates endorsed by 20/20 Vision (out of 40).

Below, a look at the economic policy implications of last week’s midterms.  

Best,

Dana

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Financial Regulation and Oversight

The Democrats’ winning the House gives Rep. Maxine Waters the gavel of the House Financial Services Committee (HFSC).  Depending on the final seat tally, between 10 and 12 new Democratic members will be added to the Committee. Waters’ vote against S. 2155 and continued opposition to deregulatory overreach will change the tone and direction of the Committee, making it unlikely that any new deregulatory bills get through the House.

Oversight is likely to be a central theme of Waters’ regime. Recent actions by the Financial Stability Oversight Council (FSOC) to de-designate the last remaining nonbank systemically important financial institution (SIFI), as well as staffing and budget cuts at the Office of Financial Research (OFR) are likely to be scrutinized. The HFSC under Waters will also be a bulwark against rulemakings and practices that increase systemic risk; regulators will likely be called in to testify, which will increase public accountability, and perhaps slow down the deregulatory agenda. Kathy Kraninger, a Mick Mulvaney acolyte, looks set to be confirmed as CFPB director by the Republican-controlled Senate, so a Waters-controlled HFSC will be a welcome check on the direction of the Bureau under Kraninger’s tenure.

Democratic Senators who supported S. 2155 didn’t fare well last week.  Sens. Joe Donnelly and Heidi Heitkamp both lost their reelection bids, leaving two vacancies to fill on the influential Senate Banking Committee. The loss of Donnelly and Heitkamp opens the possibility to get different Democratic voices on the Committee, which will hopefully provide some welcome dissent to the Committee’s deregulatory program during the last Congress.  Kyrsten Sinema, the recently-announced winner of the Senate race in Arizona, could wind up with a seat on the committee given her role on HFSC. With Republicans still at the helm, the Committee looks set to continue its confirmations agenda as well as push for a fast implementation of S. 2155.

Tax Policy

During the president’s post-midterm press conference on November 7, he highlighted some legislative areas where he may be willing to work with a Democratic House.  One of those areas was tax policy. In response to a question at Wednesday’s press conference about how he’d pay for his promised 10 percent tax cut on middle-income households, the President said, “if Democrats come up with an idea for tax cuts, which I am a big believer in tax cuts, I would absolutely pursue something, even if it means some adjustments.”

While the news cycle will focus mainly on the oversight that is sure to come, as well as the messaging bills that will be introduced, the main area in fiscal policy to watch will be the possible 10 percent tax break for middle class households. The main question now is how Democrats will propose to pay for the cut. Some have proposed bills to expand the Earned Income Tax Credit, financing an increase in the program with tax increases on corporations and big businesses.

The policy areas Democrats could mine here would be expanding tax breaks for retirement savings programs, healthcare, and tuition, but many seem to be skeptical of a major overhaul like we saw in the 115th Congress. We can expect several messaging bills and potentially some technical corrections to the Tax Cuts and Jobs Act (TCJA), but it is unlikely that much will pass the Senate, let alone the president’s veto.

Political Reform

Political reform and oversight will be at the top of the agenda for Democrats in Congress come January.  A large majority of Democratic challengers, several of whom will now move into junior roles in the House, made political reform a key platform item on the campaign trail, with almost 200 progressive candidates rejecting corporate PAC money this cycle.

In the 115th Congress, House and Senate Democrats developed a plan entitled “A Better Deal for Our Democracy” (BDD). They managed to tuck some BDD provisions into the spending bill in bipartisan areas like rural broadband access, child care assistance, and infrastructure improvement. In August, the week that Paul Manafort was convicted on eight counts of fraud, Sen. Warren introduced an anti-corruption bill that proposes toughening rules on conflict-of-interest, lobbying ethics, and campaign finance reform. In the Republican-controlled Senate, Warren’s bill has little-to-no-chance of passing. House Democrats, however, are making democracy reform their number one priority in January.

On Monday, Rep. Sarbanes (D-MD) announced that H.R. 1, the first vote in the House, will be a reform package removing obstacles to voting, closing loopholes in government ethics law, and reducing the influence of political money. H.R. 1 would establish automatic voter registration, shift redistricting power from states to independent commissions, overturn the Supreme Court’s Citizens United ruling, expand disclosure mandates, and establish public financing to match small contributions.  Rep. Sarbanes admits that though the bill is unlikely to pass the Senate, it will force political reform issues to the forefront of the legislative agenda for both chambers of Congress.

Other Policy Areas of Note

There are a few issues that emerged as major talking points during this election season that we should keep an eye on moving forward:

  • Infrastructure

Infrastructure spending appears to be the best hope for a bipartisan bill in the coming Congress.  Both parties and the president publicly seem to agree that fixing and modernizing America’s infrastructure is a high priority and point of cooperation. This issue has been ongoing for years because a key source of infrastructure funding, the federal gas tax, has not been raised or adjusted for inflation in the last 25 years. President Trump has voiced support for raising the tax, in addition to signing onto a comprehensive spending package, but it remains to be seen if any infrastructure bill will come to fruition. Many observers believe that the two parties are so far apart on key aspects of an infrastructure package that the likely outcome is no bill at all or only a modest one that falls well short of the nation’s infrastructure needs.

  • Education

Many Democratic candidates campaigned on improving education at the K-12 and university levels. For K-12 public education, the focus was mainly on increasing funding in general. At the university level, many candidates advocated for reducing the costs of a four-year degree and increasing options for job training programs. With Secretary Betsy DeVos at the head, national changes seem unlikely, but newly elected Dems can work within their districts to improve local public schools and universities.

  • Healthcare

Healthcare was a cornerstone of both Democratic and Republican platforms this cycle. Democratic victories in the House will, at the very minimum, mean that further attempts to repeal the ACA will be stopped. It is possible that we will see some proposals pass through the House, with select GOP support, calling for modest expansions in Medicare. There is also likely to be an emphasis on increased protections for the ACA, primarily through oversight rather than legislation. With the Senate firmly locked down by the GOP, it is unlikely that substantial overhauls will be adopted this term.

In the end, it is not clear whether the midterm elections this year saw a true “blue wave” or more of a harbinger of still greater things. The loss of seats in the Senate — all but inevitable given the map, which reverses and favors Democrats in 2020 and 2022 — somewhat obscures the fact that Democrats might end up with their biggest gain in the House since the post-Watergate election of 1974.  This resounding win will mean that Democrats have a strong mandate to press ahead with much needed reforms, forge a progressive agenda to challenge the current GOP status quo, and chart a path to 2020.

Economic Policy Issues Throughout the 2018 Midterms (November 2)

Update 311: Economic Policy Issues
Throughout the 2018 Midterm Campaign

As we look ahead to next week’s midterms, we take a look back at four of the key economic policy themes that have played out this cycle. Across the country this cycle we have seen common themes and policies resonating with voters in seemingly disparate districts — from Appalachia to rural California.

In a long series of change elections, Democrats in the House have been able to harness the energy of a strong, grassroots movement and advocate for progressive economic policies that throw down the gauntlet to Republicans. On Tuesday we will find out if this diverse, but united freshman class will make it into the 116th Congress.

If you would like to get involved this weekend, click here to see what you can do.

Best,

Dana

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Wall Street and Financial Regulation

2018 saw the passage of the broadest deregulation of financial institutions in the post-Dodd-Frank era. The enactment of S. 2155 in May showed how Republicans in Congress — and some Senate Democrats — are still beholden to the big financial firms on Wall Street and the mega-regionals.  While the issues can be arcane and unfamiliar to voters, many candidates acknowledged the ten-year anniversary of the 2008 financial crisis by campaigning in favor of Dodd-Frank — a refreshing change to the deregulatory drumbeat on the Hill.

Among them:

  • Katie Porter in CA-45 has experience as a consumer protection attorney and has witnessed first-hand some of the unscrupulous practices of banks without proper oversight. If elected, she will be a staunch defender of the imperiled Consumer Financial Protection Bureau.
  • Amy McGrath in KY-06 calls for greater oversight of payday lenders. Her position is in stark contrast to her GOP-opponent, Rep. Andy Barr, who voted for the Financial CHOICE Act, a bill which would repeal many provisions under Dodd-Frank. Rep. Barr has also received nearly $40,000 in campaign contributions from the payday lending industry.

Two-thirds of registered voters say they are more likely to support a candidate who includes regulating Wall Street as a part of their economic agenda and 69 percent agree that weakening regulations on banks that got bailouts after the financial crisis is an example of Washington corruption.

To this end, here at 20/20 Vision, we have put together a Banking Policy Pledge for candidates and incumbents this cycle to commit to protecting the welfare of taxpayers and rejecting the deregulatory banking industry legislative agenda.

Fiscal Policy

At the beginning of the election season, GOP candidates for Congress tried to run on the success of the Tax Cuts and Jobs Act, but quickly found out that message wasn’t playing out as well with voters as expected.  Republicans passed the bill nearly a year ago and many soon realized that the majority of benefits went to corporations, not middle-class Americans. Perhaps most importantly, there is the issue of the pending $1.5 trillion increase in the deficit.

Democrats have been using the TCJA as a successful weapon against their opponents this cycle. In the PA-18 special election, Republican strategists thought the TCJA message would take Conor Lamb down. Instead, voters paid much more attention to other issues like health care, the opioid crisis, and entitlements, propelling Lamb to victory. Specifically in terms of entitlements, Democrats have been able to use the TCJA, and the accompanying hole in the federal budget, to emphasize the risks to Medicare, Medicaid, and Social Security.

Senate Majority Leader Mitch McConnell said in an interview on October 16, “[the debt] is driven by the three big entitlement programs: Medicare, Medicaid, and Social Security.” In the next Congress, Republicans, suddenly and disingenuously promoting a fiscally conservative agenda, may talk about cutting entitlements to make up for the huge increase in the deficit. Fortunately, they won’t be able to pass bills to enact that agenda without a House majority.  

Political Corruption

Though typically not a conventional economic policy issue by definition, political corruption has played an outsized role in this cycle. In a 2015 Gallup poll, 75 percent of Americans saw corruption as “widespread” in Washington. Democrats are pushing hard for voters to see their party as one that will fight corruption and make government work for them:

  • House and Senate Democrats rolled out the Better Deal for Our Democracy in May as a general anti-corruption and citizen empowerment package to capture voters’ attentions early in the midterm cycle. 
  • Sen. Elizabeth Warren exercised leadership by introducing her Anti-Corruption and Public Integrity Act in August about lifetime bans on lobbying for members of Congress.

A large majority of Democratic challenger candidates this cycle have made democracy reform a top issue, with almost 200 Democratic candidates rejecting corporate PAC money. Democrats are also incorporating the GOP tax “scam” into this messaging, which folds in easily, as nearly 83 percent of the bill’s benefits go to the top one percent of income earners.

Progressive candidates have used Republican corruption scandals this cycle, including those of the President and his close colleagues, to bolster their notion that the Democrats will implement real anti-corruption and empowerment solutions.

Democrats have also focused on local corruption issues, such as Rep. Scott Taylor’s third-party fraud in VA-02 and Rep. Duncan Hunter’s misuse of campaign funds CA-50. In these key districts, Democrats are using this platform to win over minority constituents and independents, who are fed up with the status quo and looking for leadership to get government working for people, instead of wealthy special interests.

Healthcare

This election cycle, candidates everywhere are referring to healthcare as the top economic issue for their constituents and therefore, for their campaigns.  For Democratic candidates, protecting what is left of the Affordable Care Act (ACA) has become the baseline priority of the cycle. The repeal of the individual mandate, further attempts to gut the ACA, and Trump’s continued calls for rescinding protections on pre-existing conditions threaten millions of Americans’ coverage and well-being.

In states where the effects of the opioid epidemic are felt, we are seeing Democratic candidates gain ground in typically safe GOP districts, such as PA-01 or VA-05.  In party strongholds, establishment figures have been upended in several primaries by grassroots challengers, like Alexandria Ocasio-Cortez, who advance progressive policies such as Medicare-for-all.

Republicans, in contrast, are divided. Many GOP candidates have found themselves in a bind and have shifted their positions after the failed attempt to repeal the ACA. Their campaigns have turned to focus on other topics, like immigration. GOP support from older constituents is particularly hemorrhaging over the issue of repealing protections against pre-existing conditions. At the party level, there is virtually no consensus by the GOP on healthcare. Candidates find themselves backtracking on earlier calls to repeal the ACA as their voters strongly rely on, or approve of, existing ACA provisions. Facing the prospect of millions of Americans going uninsured, the Republican party and the majority of Americans find themselves at odds.

Senate Banking Hearing Tomorrow — Why is Implementation So Slow? (October 1)

Update 302: Senate Banking Hearing Tomorrow
on S. 2155 — Why is Implementation So Slow?

When the Economic Growth, Regulatory Relief, and Consumer Protection Act (S. 2155) was signed into law four months ago, we saw risk, not a reason to rush implementation. Industry apparently sees otherwise and so Senate Banking will ask why it’s been so slow.

Per a recent survey of registered voters by Better Markets and The Harris Poll, 58 percent either wanted a return to the protections put in place after the financial crisis or additional regulation on banks with over $50 billion in assets. 70 percent of Democrats, 53 percent of independents, and 49 percent of Republicans agreed.  

A majority of voters disagree with S. 2155’s deregulatory agenda. Policy aside (or see below), just five weeks out from the midterms, is this the time for lawmakers to showcase support for, let alone demand rapid implementation of, the biggest rollback of Dodd-Frank yet?

Best,

Dana

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Industry Interest

The supervisory regulatory relief to community banks, the provision at the center of S. 2155’s advertising, is not extensive.  In raising the Federal Reserve’s Small Bank Holding Company Policy Statement from $1 billion to $3 billion, small banks that qualify may apply for a longer supervisory examination cycle of up to 18 months. Should they meet the appropriate criteria, banks with under $5 billion in assets will enjoy relaxed reporting requirements in the first and third quarters. For community banks holding over $5 billion in assets, this supervisory relief applies less, focusing on modest changes in capital requirements and mortgage regulations, and exemption from the Volcker rule.

The ratcheting up of the SIFI designation threshold from $50 billion in consolidated assets to $250 billion, which has almost no direct impact on community banks, was the number one legislative goal of the ABA much of this decade. . Title IV of S. 2155 does precisely that, and why the banking sector wants the title implemented yesterday is not a mystery.

Not everyone is enthused.  Sheila Bair, the FDIC chair during the financial crisis, says that S. 2155 sets “a dangerous global precedent [and] now some in [Congress] have decided to side with self-interested bankers.  They argue our stronger capital rules put US banks at a competitive disadvantage, even though they have come to dominate global finance.”  Industry has already expressed its gratitude to Democratic members of the Banking Committee in tight re-election races in red states like Indiana, Montana, North Dakota, the leading recipients of commercial banking largess.  Democrats trying to present S.2155 as a small-bank bill have some ground to stand on, but also run a serious political risk.

Two Steps Forward, One Leap Back

As we have moved farther away from the Great Recession, much of the public has forgotten what precipitated the crisis. S. 2155’s deregulatory measures take us closer to pre-recession conditions rather than farther by undermining a fundamental pillar of the post-2008 regulatory regime.  Although the bill’s messaging is centered around helping community banks, the real winners are the midsize to large regional banks.

Section 401 loosens regulations on 25 of the top 40 largest banks by increasing the asset threshold for the automatic application of post-crisis safeguards, known as enhanced prudential standards, from $50 billion to $250 billion.  These 25 banks together hold $3.5 trillion in assets and collected a total of $47 billion in Troubled Asset Relief Program (TARP) funds during the financial crisis.

401 also provides the biggest rollback thus far of DFA, which was put in place to strengthen regulation after the Recession.  Although the bill gives the Fed discretion to re-apply enhanced prudential standards to those banks with assets between $100 and $250 billion,  President Trump’s appointees, which include Vice Chair of Supervision Randal Quarles, are unlikely to do so. In addition to these already risky changes, the bill also complicates the stress testing system and loosens requirements for the liquidity coverage ratio.  The result? A less-insulated financial system with far greater systemic risk.

Questions Remain

As we head into tomorrow’s hearing, important questions remain on the implementation and interpretation of S.2155 by the various agencies involved:

  • Given the fact that Lehman Brothers had $150 billion in assets when it collapsed during the financial crisis, isn’t the Fed’s newfound discretionary designation power still critically important?
  • What methodologies and procedures will the Fed use to make a determination on whether a bank between $100 billion and $250 billion in assets should face enhanced prudential standards?

Fed Chair Jerome Powell suggested in his most recent press conference last week that post-crisis designation powers on nonbanks, while important, should be used “sparingly.” This seemingly innocuous comment comes as other agency chiefs are considering weakening other discretionary powers in the wake of S. 2155.  The American people (and voters) may not forgive nor forget a future financial crisis conceived in the legislative details of a lobbyist’s bill in Washington.

Review of the Banking Sector (September 21)

Update 300: Review of the Banking Sector; the Irony of Records Being Set Amid Deregulation

Today we go back to basics with a quarterly review of the health of the financial sector and the disparate sub-sectors comprising it. Industry has fostered misrepresentations of the state of the sector claiming to be hamstrung by regulation and suffering consolidation. Its reason is because Dodd-Frank is working all too well and yet still beset by Too Big To Fail because it isn’t working.   

In fact, never have revenues been higher, margins bigger, market caps bigger, salaries and bonuses bigger… and competition keener.  We’ll take the issue up again on October 2 when Senate Banking holds a hearing on the “Implementation of the Economic Growth, Regulatory Relief, and Consumer Protection Act,” where the panel will re-examine whether bank deregulation makes sense given the current cyclical condition of the sector.  

Good reading and good weekends all…

Best,

Dana

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The Banking Sector’s Big Boom

  • Credit Unions

Prior to the passage of S.2155, credit unions were profiting significantly through market consolidation as they continued to gain more market share in areas underserved by community banks. In fact, they have increased their overall market share from around 6 percent at the start of the financial crisis to 7.4 percent in 2017. In other words, credit unions were doing better than ever and were not in need of further deregulation. Despite this, credit unions claimed a large victory in the deregulatory policies of S.2155, the Economic Growth, Regulatory Relief and Consumer Protection Act. Credit unions, along with community banks, received some deregulatory benefits in the bill, but the lion’s share of the benefits in S.2155 still went to the Wall Street elite firms.

  • Community Banks

Since the financial crisis, the condition of community banks has improved considerably. Community banks range from institutions with less than $1 billion in aggregate assets up to institutions with under $10 billion.  One of S.2155’s most notable changes raised the total asset threshold for submission to annual Federal Reserve stress testing from $50 billion to $250 billion, ostensibly not affecting community banks. This increased threshold does give more leeway to small banks looking to grow their asset size, because banks would have to hold over $250 billion in assets before being subjected to enhanced prudential standards.  However, the Fed could use its discretion to apply these standards to banks with between $100 and $250 billion in assets.

  • Midsize Regional Banks

Ten years out from the financial crisis, midsize regional banks also continue to improve.  Some of these banks, buoyed by the 2017 tax law, higher interest rates, and rising commercial bank loans, have almost doubled in size since 1Q 2017. Midsize regional banks gained the most by far from S.2155. Loosening regulatory scrutiny, including automatic enhanced prudential standards, on banks with assets up to $250 billion, hugely benefited the 24 mid-sized regional banks. These banks include household names like PNC, Capital One, SunTrust, and BB&T — not small, community-oriented banks. Rather, precisely these kinds of banks — institutions on their way to becoming banking giants and providing services and loans to the average American — need federal oversight.

  • Wall Street Elite Firms

In the years since the financial crisis, the nation’s elite banks have grown exponentially. The top 15 largest banks, including the likes of J.P. Morgan, Morgan Stanley, and Goldman Sachs, now hold a combined total of over $13 trillion in assets. The top six banks have also experienced record profit growth in recent years, seeing double-digit increases in just the last year from 2Q 2017 to 2Q 2018.

Source: Wall Street Journal

Republicans in Congress, and some Democrats, are deregulating under the guise of helping the little guys — community banks and credit unions — while many of the benefits are actually going to the top 100 financial institutions. Big banks continue to push for deregulatory measures, all the while continuing to benefit from the windfalls of S.2155 and the Tax Cuts and Jobs Act (TCJA).

Underfunded, Understaffed, Undermined

While financial institutions are basking in the golden age of banking, federal agencies are under attack. Crucial regulatory and oversight agencies are undergoing severe budget and staffing cuts, and the Trump Administration and the GOP Congress remain hellbent on weakening protections under DFA.

  • FSOC/Fed: Last week, the Financial Stability Oversight Council (FSOC) used its discretion to remove the systemically important financial institution (SIFI) status of Zions Bank, which was the first time that FSOC has used its powers to de-designate a bank’s systemic risk label. It may be a sign of things to come, as the Fed now has the discretion to apply whatever prudential standards it deems necessary to banks under the new $250 billion threshold. During the same meeting last week, FSOC also reviewed insurance giant Prudential’s status as the one remaining non-bank SIFI. The council did not reach a decision, but the consensus among experts close to the matter is that Prudential’s status as a nonbank SIFI is in jeopardy. Ten years after the financial crisis and the dramatic collapse of American International Group (AIG), FSOC is on the verge of rendering one of the key DFA protections defunct. 
  • OFR: The research arm of FSOC, the Office of Financial Research (OFR), which is charged with seeking out problems in the financial system and raising them with regulators, is being decimated under the current administration. In January, the administration signaled that it was looking to cut OFR’s budget by 25 percent, to around $76 million; in August this year, around 40 staff members were laid off, as the agency’s headcount target is down 65 percent from its peak. The current nominee to head the office, Jeb Hensarling’s chief economist Dino Falaschetti, is a curious choice given Hensarling’s complete disdain for the agency and its mission. 
  • OCC/FDIC: In April of this year, the Office of the Comptroller of the Currency (OCC) and the Federal Reserve issued a joint notice of proposed rulemaking (NPR) to make changes to the Enhanced Supplementary Leverage Capital Ratio (eSLR). This change would reduce capital requirements for the eight global-systemically important banks (G-SIBs) at their insured depository institutions by $121 billion, equivalent to a 20 percent reduction in capital. Current FDIC Chair Martin Gruenberg and two former FDIC chairs, Sheila Bair and Thomas Hoenig, have all spoken out against the NPR, arguing that the proposed changes are unnecessary and threaten financial stability.

Banks Turn to Lobbying

In an attempt to strengthen their image and weaken regulation, banks have turned more aggressively towards lobbying efforts.  Formed from a recent merger, the Bank Policy Institute (BPI) represents over 48 of the largest banks of the United States, whose combined lending accounts for 72 percent of all loans issued in the country. It is staffed by analysts, researchers, and attorneys, and is overseen by a Board of Directors consisting of some the largest names in the banking sector including the CEOs of Bank of America, Citigroup, and JP Morgan Chase.

BPI’s agenda is unsurprisingly aimed at further deregulation of the banking industry in an attempt to whittle down the regulatory regime that was established after the 2008 financial crisis. The Institute announced this week that it was hiring two top lobbyists to push for its legislative agenda. Some of their goals include lowering reserve requirement ratios and repealing self-funding requirements on lending.

Was S.2155 Worth It?

The aforementioned issues will come to a head on October 2, during the upcoming Senate Banking Committee hearing on the implementation of S.2155. There, we are likely to get a fair hearing on why risky deregulation should go forward when the sector is so flush. Fortunately for supporters of S.2155, costs of regulation are examined much more closely than costs of deregulation, a long-standing norm that makes it easier to deregulate and harder to regulate.  The SBC hearing in October will offer an excellent, hopefully balanced, picture of the benefits and the costs of S.2155, as well as a key platform for exploring the irony of deregulating this flush, prosperous, growing, systemically significant sector.

JOBS Act 3.0 — S. 2155 Redux Writ Small? (July 20)

Update 286:  If at First You Do Succeed…JOBS Act 3.0 — S. 2155 Redux Writ Small?

On Monday, a package of financial regulatory measures (deregulatory in aggregate effect), cleared the House overwhelmingly and has joined the short-list of bills on the Senate’s post-recess floor time queue.  JOBS 3.0 raises plenty of non-Dodd-Frank issues, but it also raises S. 2155 on a smaller scale, with something for everyone to loathe or love.

On a related note is an event next Tuesday, July 24, sponsored by Americans For Financial Reform:  “Regulating Wall Street – Ten Years Later.” Sens. Sherrod Brown and Elizabeth Warren are among the featured participants.  To RSVP, click here.  

Best,

Dana

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JOBS Act 3.0

This week, House Financial Services Chair Jeb Hensarling and Ranking Member Maxine Waters announced a bipartisan agreement on the terms of a broad regulatory rollback package.  The legislation, entitled S.488, the JOBS and Investor Confidence Act of 2018 (or Jobs Act 3.0), is the most comprehensive package of changes to federal securities laws to pass the House with broad and bipartisan support since Congress approved the JOBS Act of 2012.  [NB: in 2015, Congress enacted a much smaller set of tweaks to securities laws as part of broader transportation reauthorization legislation, which some have dubbed “JOBS Act 2.0”.]

S.488 is comprised of 32 previously introduced bills, the vast majority of which have cleared the House or the Financial Services Committee.

This third iteration of the JOBS Act has many of the hallmarks of the JOBS Act of 2012.  It combines a number of disparate and seemingly innocuous pieces of legislation that relax or moderate various existing regulatory requirements relating to U.S. capital markets, in particular, the issuance and sale of securities.  

The House passed the package on a 406-4 vote on Tuesday with bipartisan support, including from Ranking Member Maxine Waters and Chairman Jeb Hensarling. It looks like the Senate will consider the bill in the next couple of months.

Public-Private Market Paradox

The JOBS Act 3.0 package contains provisions that simultaneously seek to encourage growth in the public market, while cutting back on regulations in the private market.

The bills include:

  • H.R.79: The HALOS Act permits issuers of private securities that are exempt from SEC registration requirements pursuant to SEC Rule 506(b) to also be exempt from certain restrictions on the use of general solicitation in the advertising and sale of such securities, further weakening investor protections in a segment of the market that is growing rapidly but plagued by fraud.

Private securities markets are appropriate for certain types of issuers and investors, but they are inherently problematic, given that they are characterized by significant risk — lack of liquidity, oversight and transparency.  The private nature of these markets also makes it difficult for investors other than large institutional investors or venture funds to obtain information about the security, or otherwise value the security.

  • H.R.5877: The Main Street Growth Act lays the statutory foundation for the establishment of one or more “venture exchanges.” The Act sets forth a process under which any national securities exchange registered with the SEC can “elect” to become a venture exchange, which is subject to different standards and rules than those that govern all other national securities exchanges in the United States.

The venture exchange provisions in S.488 build upon provisions enacted in Section 501 of S.2155 that dramatically changed the way securities can be recognized as “covered” and exempted from state review by virtue of being listed on a national securities exchange. Taken together, the two provisions will ensure that certain national exchanges in the U.S. will likely operate with significantly lower listing standards than those that currently apply to national exchanges.

  • H.R.6177: The Developing and Empowering our Aspiring Leaders (DEAL) Act requires the SEC to allow venture capital funds to invest in secondary market shares of venture capital companies instead of primary offerings, complementing the “venture exchange” piece of the larger bill by basically creating an ecosystem for trading shares in private venture companies.

This Act, together with the HALOS and Main Street Growth Acts, further blurs the distinction between public and private securities markets, expanding the “quasi-public” securities market that was the major legacy of the JOBS Act of 2012, and making it more likely that retail investors will soon be solicited and sold securities that are in many respects more speculative and risky than is currently permitted under the securities laws.

  • H.R.1645: The Fostering Innovation Act ostensibly aims to encourage IPO formation by doubling the time that low-revenue emerging growth companies (EGCs) are exempt from key financial reporting controls. However, the Act is predicted to affect less than 2 percent of publicly traded companies and is therefore unlikely to have a discernible effect on increasing the amount of IPOs. Crucially, the bill gives special treatment to EGCs, opening the door for other issuers to demand the same and potentially precipitating a “special treatment” race to the bottom. The long-term effect of lowering the bar for a few is that the bar gets lowered for all.

A Work in Progress

  • H.R.1585: The Fair Investment Opportunities for Professional Experts Act sets in statute the definition of an “accredited investor” and codifies the current thresholds for annual income and net worth. The bill would create new qualitative pathways for individuals to become accredited and attempts to address the $1 million asset threshold that was originally set by rule in 1982 by indexing it to inflation every five years. However, even with the inflation adjustments, the bill would see retirees with no experience or sophistication in investment matters qualifying as “accredited investors” by virtue of their retirement savings, or wealth realized from an event such as an inheritance or the sale of a primary residence. This bill could be amended to rectify these important issues in the Senate, but in its current form, it is an example of the unbalanced nature of some of the bills in the JOBS 3.0 package.

Regulatory Risk

Where most bills in the package relate to capital markets access, two pertain to the systemic risk pillars of stress testing and resolution planning.

  • H.R.4566: The Alleviating Stress Test Burdens to Help Investors Act exempts nonbank financial institutions from DFA company-run stress-testing requirements.
  • H.R.4292: The Financial Institution Living Will Improvement Act requires banks to submit resolution plans every two years instead of annually. These measures mimic what regulators may already decide with newfound discretion under S.2155.

Improvements to JOBS Act 3.0

JOBS Act 3.0 is modest compared to its predecessors, but underwent significant changes during its crafting. Therefore, in some cases, the bills that have been incorporated in the package are different than the previous iterations. The package has been welcomed by some institutions, such as the Council of Institutional Investors, for its provisions that address insider trading and multiclass share structure disclosure.

Unfortunately, the speed with which the package is and has been moving has made it difficult for those on and off the Hill to properly evaluate its benefits and risks. With so many moving parts, JOBS Act 3.0 needs time to be fleshed out and examined more thoroughly before concrete suggestions can be made. This is likely post-August recess.

Political Developments/State-of-Play

S.488 now moves to the Senate. With the legislative schedule packed with nominations, appropriations bills, and the Farm bill,  Senate Majority Leader McConnell announced that “Senators will continue their ongoing bipartisan discussions as we work towards a vote in the coming months.”  

Other Senators have indicated the negotiations and busy schedule could push the floor debate for at least three to four weeks.  Look for the package to reach the Senate floor after the summer recess, perhaps attached to a funding or appropriations bill, or as standalone legislation.