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?




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…




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.

Trump Floats Tax Cuts by Decree Called “Illegal, Flat-Out Bonkers” (August 1)

Update 289:  Trump Floats Tax Cuts By Decree Called “Illegal, Flat-Out Bonkers;” Is it News?

The GOP impulse to overreach when it comes to tax cuts is gaining almost frantic momentum right before the the August recess, as the GOP’s hopes of keeping its majorities in Congress looks ever more remote.  

Last week it was Tax Reform 2.0.  This week, it is an aggressive approach to capital gains: index them for inflation.  The Trump administration is eyeing yet another tax cut for the wealthy, this time bypassing Congress and using executive power to push another plutocratic windfall under the family and friends plan.  

Details of the plan, if you can stand them, revealed below…




Treasury Secretary Steven Mnuchin has confirmed in recent data that his Department is in fact looking at the “tools” necessary to change tax law, without seeking Congressional authority, to index capital gains for inflation for income tax purposes.

The Tax Policy Center estimates that the change would cost the country’s coffers $100 billion over ten years — with more than 97 percent of the tax savings going to the top 10 percent of earners, and nearly two-thirds going to the top 0.1 percent.

Screen Shot 2018-08-08 at 9.27.09 AM.png

Source: Tax Policy Center

Indexing Cap Gains — What Does it Mean?

Capital gains taxes are assessed on the difference between the sale price of an asset and its original cost basis.  The proposed change would adjust the original cost of the asset for inflation, reducing the tax burden on taxable gains and potentially saving wealthy individuals millions of dollars in tax liabilities.

For example:

  • Under current law, if you bought $10,000 worth of stock in 1980 and it grew to be worth $40,000 by the time you sold it in 2018, then you’d pay capital gains taxes on the difference between what you sold the stock for and what you bought it for ($30,000).
  • Under the proposed changes, the original purchase price of the stock would be adjusted for inflation. From 1980 to 2018, the dollar experienced an average inflation rate of around 3 percent a year. In other words, $100 in 1980 is equivalent to $300 in 2018.

  • In the example above, the original purchase price would be inflation adjusted from $10,000 to $30,000 to reflect the fact that prices had tripled over the period, and the indexed capital gain would go from $30,000 to just $10,000.

  • Consequently, in the scenario above, you would only pay taxes on $10,000 — reducing the capital gains tax liability by a whopping two-thirds. The change would provide a huge windfall for wealthy individuals on their long-term investments at the expense of the federal budget deficit.

History of Treasury Unilateralism

Constitutional Issues

In 1992, the National Chamber Foundation (NCF) requested legal consult to discern if the Treasury, by regulation, could index capital gains to inflation. They decided Treasury did have the power to do so. The NCF memo relied on the Supreme Court legal doctrine of Chevron Deference to administrative agencies and what they thought of as the ambiguous definition of “cost basis” in the IRS Tax Code.  

The Treasury independently concluded that they did not have the legal authority, but President George H. W. Bush asked the general counsel of the White House to assess the NCF memo, as well. The conclusion from the counsel affirmed that Treasury did not have the sought-after regulatory power for a few reasons:

  • If the intent of Congress is clear then there is no blanket authority for regulatory rewriting of statutes, according to Chevron Deference.

  • Congress had repeatedly considered proposals to index capital gains for inflation but had not sent any to the President to be enacted.

  • Legislative history evidences a clear congressional intent that “cost” be given its common and ordinary meaning, that is, price paid in normal dollars not adjusted for inflation.

The Congressional stance on indexing capital gains has not changed since 1992. For these reasons, the same conclusions reached by the general counsel in 1992 would still apply. There would almost certainly be a swift court challenge if Secretary Mnuchin goes through with the plan.

Legislative Efforts

Various other indexing measures have been introduced in the past two decades, but none have progressed past committee and almost none were the subject of a floor speech or debate or a committee report. Most recently, in early 2018, Sen. Ted Cruz introduced a bill to index capital gains to inflation. It was referred to committee but no action has been taken since. No one has co-sponsored this bill.

(Capital) Gains for Some, Not for Most

In addition to the incredible regressivity of the tax cut and the $100 billion hole in the federal budget it would create, there are other issues that would make indexing capital gains a bad move.

  • Indexing capital gains will create tax shelters: “If you index the asset side of ledger but don’t index liabilities, you have a clear arbitrage for debt-financed investments,” according to Steven Rosenthal from the Urban-Brookings Tax Policy Center. In other words, if you index capital gains, without indexing capital expenses, this creates tax arbitrage opportunities for savvy taxpayers who might look to take advantage of these inefficiencies. Yet another sign that the Administration seems hellbent on creating opportunities for those who can afford it (themselves) to game the system.

  • Indexing unknowns: There are still lots of questions to be answered on the logistics and substance of such a change. What price index would be used? What assets would be included/excluded? Would the change be an addition or substitute for existing tax benefits? Would indexing cover both past and future inflation? Could indexing create or exacerbate capital losses?

At the end of the day, the proposed change to index capital gains to inflation is a blatant and brazen attempt to appeal to the wealthiest Americans in an attempt to pry open their checkbooks before the midterms, as well perhaps to those who imagine being wealthy enough to benefit someday.  

If at First You Don’t Succeed, Bypass Congress

The overreach of the Administration in pushing such an unpopular and untimely move, even with the certainty that any such change would be challenged in court, shows how much it prioritizes fulfilling the desires of GOP donors while controlling the Congressional majority.  

Despite a vocal minority of Republican legislators led by Sen. Ted Cruz, there doesn’t seem to be widespread Republican support for indexing capital gains to inflation. Legislatively, both now and in the past, nothing concrete has been done on this issue. In fact, even in the most recent tax bill passed by Congress, the Tax Cuts and Jobs Act, they left capital gains alone. Logically, if there were widespread support and it could be easily passed by Congress, the measure would not need to be unilaterally carried out by the executive branch.

In the Tax Cuts’ Wake (May 7)

Update 269: In the Tax Cuts’ Wake:
Pensioners, Workers to Pay the Piper

Whether the GOP will campaign on last year’s tax cut is a central question of the midterm season.  American taxpayers aren’t as enamored by this as much as similar cuts in the past. The sense has taken root, stoked by Paul Ryan and other GOP leaders, that there is no free lunch and there is no free tax cut.  And that the price to pay — the fiscal bill for the multi-trillion dollar cut bill — will come from entitlements.

Is this all smoke?  Or is there fire here regarding the most incendiary issue one could want in an election year?  We look at the state of and the prospect for a GOP threat to entitlements this year.

Speaking of, next — the first in our series of updates on primary election results this Wednesday following tomorrow’s primaries in Indiana, North Carolina, Ohio, and West Virginia.




Tax and the Imbalancing Act

As Republicans in Congress passed a tax bill in December that greatly deepened America’s fiscal hole, those preparing for and in retirement across the country gulped, for they sensed what was coming.  The resulting annual trillion dollar fiscal deficits carries acute consequences for them.

There are two crisis points in today’s retirement system: a chronic multiemployer pensions crisis and the depletion of the Social Security Disability Insurance (DI) and Old Age Survivors Insurance (OASI) Funds.


Prospects for America’s Retirees

Today, millions of America’s retirees are leaving the workforce with almost nothing in savings.  42 percent of Americans have less than $10,000 set aside for retirement. The retired are forced to spread meager savings over a longer time period, as average life expectancy has increased by 20 years since the 1930s.  Seniors must also face rising costs of care to deal with failing health.

By 2035, a typical senior will spend one out of every seven dollars of retirement income on medical care, a 40 percent increase from 2012.  According to the Supplemental Poverty Measure (SPM), 7.1 million adults ages 65 and older (14.5 percent) live in poverty. These figures will only worsen if Social Security and Medicare funds become solvent.


Entitlement Programs’ Financial Security

Social Security funds are stable today, but last year, the Social Security trustees projected they will not be in ten to fifteen years. Over the next decade and a half, voters concerned about their retirement have a few dates to keep in mind:

•  the Disability Insurance (DI) trust fund will deplete by 2028
•  the Old Age Survivors Insurance (OASI) trust fund will deplete by 2035
•  combining the two funds, social security is expected to deplete in 2034

After these years, revenue would be able to pay out just 77 percent of scheduled beneficiaries. Under the Social Security Act, beneficiaries are legally entitled to their full scheduled benefits. Nevertheless, a conflicting law, the Antideficiency Act, prohibits the federal government from spending in excess of available funds – tying the Social Security Administration’s hands.

The result could mean retirees suffer from receiving benefits on a delayed basis or receiving benefits on the same schedule but at reduced levels. Since retirees are legally owed their full benefits on time, expect substantial legal action to take place.



These projections were issued just before the passage of the Tax Cuts and Jobs Act (TCJA). With the new tax law,  Republicans claimed to help reduce the average person’s taxes today. What the GOP did not mention is that diminished revenues over time will exert downward pressure on the government’s ability to compensate for shortfalls in Social Security trust funds.


OASDI net cash flows as a percentage of GDP, 1957–2009, projected under the intermediate assumptions, 2010–2085; SOURCE: Social Security Administration, Office of the Chief Actuary.


Ongoing Crisis: Multiemployer Pensions

Even today, the TCJA is siphoning resources from retirees, as they are short-changed in the multiemployer pension space. Republicans have done nothing to address the issue.

Pension plans of all kinds were undermined by two financial market crashes between 2000 and 2009. Among the factors in addition to market crashes that harmed multiemployer pensions were a declining union workforce, global competition, technology, and the ratio of retirees to active participants.

PBGC’s Multiemployer Program

Multiemployer plans are meant to allow related small businesses and large companies to pool resources to provide for workers in old age. These plans are insured by the US Federal Government’s Pension Benefit Guaranty Corporation, with 10 million Americans participating in about 1300 plans.

Until 2004, the PBGC’s multiemployer insurance pool was operating with a surplus, but the 2008-2010 financial crises had a dramatic impact. Now the program is projected to become insolvent in 2025. Once its funds are depleted, the PBGC will likely only be able to pay a fraction of the (already low) guaranteed benefits – as little as 10% of original benefits for some pensioners.

There are about 100 multiemployer plans covering nearly 1 million participants deemed “critical and declining.” While this means that a majority of multiemployer plans are healthy, the entire multiemployer system is fragile, and part of the solution needs to consider how to keep all participants (the struggling and the healthy) in good shape over the long haul.

Congressional Activity on Multiemployer Pensions

•  The MPRA: The Multiemployer Pension Reform Act (MPRA) of 2014 has not solved the problem. The MPRA addresses plans currently in crisis but does not help to strengthen plans or help workers prepare for the future.
•  The Joint Select Committee: With pressure from Teamsters, retirees, and unions, congressional leaders passed the Bipartisan Budget Act of 2018 which created the Joint Select Committee on Solvency of Multiemployer Pension Plans to address the impending insolvency of large multiemployer defined benefit pension plans and the PBGC.  The Committee is required to propose legislative language to improve solvency by November 30, 2018.
•  The Butch Lewis Act (H.R. 4444/S.2147): Sen. Brown introduced this act along with Rep. Richard Neal. A few House Republicans have praised the bill as well.  The Act would create the Pension Rehabilitation Administration (PRA) to lend money on very favorable terms to the troubled plans, who can show they will eventually be able to repay the loan.


Going Forward

With the 65+ population rising as Baby Boomers retire, Social Security burning through its funds, the PBGC depleted, and the TCJA sapping revenues across the board, the situation is becoming unmanageable. A handful of ideas could strengthen Social Security and help prevent its depletion:

•  fully index benefit payments for inflation to help retirees keep up with rising costs,
•  raise the $128,700 taxable maximum cap on the FICA payroll tax to raise revenue from wealthier taxpayers,
•  expand compensation subject to FICA taxes to include capital gains rather than exclusively salaried income,
•  create earnings credits for people who are not working because they are caring for a child or a family member and for those who work in noncovered jobs,
•  implement a new minimum benefit to keep low-paid workers above the poverty level, and
•  redirect OASI funds to the DI fund to prolong the life of DI to 2034.

Dealing with an entitlement crisis is not a question of if but when. With the action being taken by Congressional Republicans, the crisis has become even more imminent. Unless steps are taken to strengthen SS, we will have a lot of angry retirees and newly influential Democrats on our hands.

Dereg Now, Dereg Whenever (Apr. 25)

Update 266 – Dereg Now, Dereg Whenever:
Capital Rules Debate Pits Quarles vs. Quarrels

If rapidly increasing economic growth, historic highs in financial industry profits, and capital markets in record territory of late all call for deregulation, there’s no bad time for it.  And if proponents of financial deregulation control the House, Senate, and White House — for now — this is most certainly the time, regardless of sectoral circumstances.

Here’s the story of the GOP working with financial regulators and market participants to bring down the “hairpin turn ahead” sign because no more accidents were occurring.




Last Week, Federal Reserve Vice-Chair for Supervision Randal Quarles appeared before House and Senate Committees to answer questions on his approach to supervisory standards.  In recent weeks, the Fed has issued revisions to a number of fundamental post-crisis standards. Quarles’ innocuous words like “efficiency” and “recalibration” belie the serious systemic implications these rulemakings have.  Leading regulators at the Fed and other regulatory bodies have raised important objections.

This while a Senate Banking bill, S.2155, sits at the doorstep of the House.  The Economic Growth Regulatory Relief and Consumer Protection Act would empower the Fed to free 25 of the largest 34 banks from stress testing, living wills, and the liquidity coverage ratio.  Quarles’ rulemakings suggest he is eager to tailor the same DFA pillars that S.2155 would deregulate.

These efforts look like a solution in search of a problem. The banking sector has been unprecedentedly profitable for three years running, lending remains strong, and the economy as a whole is gaining steam.

GOP Regulatory Pref: Capital over Supervisory

Reduced capital levels run counter to what some Republican appointees and officials have suggested about the value of capital requirements. In 2016, then-Chair of the Senate Banking Committee Richard Shelby said that for years, he has “urged regulators to implement strong capital standards.”  Just a year ago, Jerome Powell suggested capital levels were just right. Now in power, conservatives seem determined to relax rules for the largest banks under the guise of “modernization,” a familiar deregulatory term.

Capital Regimes Pre- and Post-Crisis

Capital held by the five largest banks doubled from 2008 to 2015, but only from 3 percent to 6 percent. Today, equity capital requirements range from 7 percent to 11 percent of risk-weighted assets, but it appears Quarles is primed to permit a reduction in capital levels.

Proposed Revisions

Enhanced Supplementary Leverage Ratio (ESLR) – On April 11, the Federal Reserve and the Office of the Comptroller of the Currency (OCC) issued a proposal to reduce the enhanced supplementary leverage ratio capital rules applied to Globally Systemically Important Banks (G-SIBs) and their subsidiaries. The proposal’s impact varies from bank to bank, but would slash some ESLR by up to 40 percent. Currently, G-SIBs must maintain a minimum SLR of more than 5 percent (3 percent plus a 2 percent buffer). G-SIB subsidiaries must maintain a 6 percent SLR. The new proposal would take the 2 percent buffer and turn it into a figure equal to one half of the firm’s GSIB surcharge. Subsidiaries’ SLRs would fall from 6 percent after similar tailoring.

•  The FDIC estimates this will result in the GSIB subsidiaries holding $121 billion less in capital at their FDIC-insured subsidiaries. Quarles sought to temper critics who cite this figure by predicting that aggregate capital will fall by just $400 million among bank holding companies. Nevertheless, the discrepancy here is troubling, indicating the Vice-Chair does not see systemic risk residing in subsidiaries across these firms’ operations. In the past, it was the norm for the regulatory bodies like the Fed and FDIC to be on the same page when it comes to capital requirements.

Stress Testing/Capital Buffers – On April 10, the Federal Reserve proposed a new “stress capital buffer” that totals the amount equal to losses incurred during a hypothetical stress test or 2.5 percent, whichever is greater. The revision would replace the existing requirement that 2.5 percent of risk-weighted assets be held as capital. It also replaces the quantitative objection to a firm’s capital plans under CCAR.  Under the new proposal, if a bank has common equity tier 1 capital of 8 percent and it falls to 5 percent, the bank’s stress capital buffer would be 3 percent. This would be added to the minimum 4.5 percent common equity requirement to total 7.5 percent. Federal Reserve estimates suggest this will lead to increased capital among GSIBs, but lower levels of capital among non-GSIBs.

Some analysts are concerned, however, that the loosening of assumptions related to balance sheet growth and the time horizon for expected dividend payments, would ultimately reduce overall capital levels. Recent stress testing data projects these proposals would lower capital at major banks by $30 billion. Goldman Sachs expects the eight largest banks to reduce equity capital by $54 billion as a result of potential stress test changes.

New accounting standard for loan losses – Federal reserve rules include a new accounting standard for loan losses.  This is significant, as it requires banks to forecast and set aside money for easily foreseeable loan losses before they occur. In the lead up to the financial crisis, banks were not recognizing losses well. Since capital rules are in place to guard against unforeseen losses, combining loan loss projections (for anticipated losses) with capital requirements is potentially dangerous.


Source: Federal Reserve Bank of Atlanta; Federal Financial Institutions Examination Council; Journal of Economic Perspectives; Keefe, Bruyette & Woods; regulatory filings


Brainerd on Cyclicality – In the first dissent since the Federal Reserve began to publicly disclose votes, Governor Lael Brainard voted in opposition to a rule that slashes the enhanced supplementary leverage ratio. In a recent speech, Brainerd said it was too soon to consider lowering capital requirements for big banks and urged against making judgements about the current capital and liquidity coverage before a full economic cycle has been completed.

•  Gruenberg on ESLR – FDIC Chair Martin Gruenberg reaffirmed support for the SLR set in 2014, refusing to join the Fed and OCC in issuing the new proposed rule. Gruenberg said leverage ratio requirements are “among the most important post-crisis reforms,” and that “the existing simple approach has served well in addressing the excessive leverage that helped deepen the crisis.”

•  Sen. Warren – At last week’s Senate Banking Committee hearing, Sen. Warren reminded Vice Chair Quarles that taxpayers were left holding the bag when the big banks didn’t hold enough capital. Under the new rule, JP Morgan, Citigroup, and Morgan Stanley could reduce capital by more than 20 percent at their bank subsidiaries and still meet leverage capital requirements. Wells Fargo and Bank of America can each reduce their capital by more than 15 percent.

•  Wall Street Journal – Even the Wall Street Journal’s editorial board criticized the Fed’s proposed supplementary leverage ratio reduction. The board pointed out that the current 6.6 percent leverage ratio among GSIBs is only slightly greater than their losses during the stock market crash in 2008. Reducing them any further would only endanger the system, the editorial board argued.

S. 2155 in this Context

These proposals reflect Quarles’ apparent objective, to include risk-profiling in the financial regulatory capital regime.  Increased tailoring of enhanced prudential standards has been a primary post-crisis goal of congressional Republicans. Critics see tailoring as little more than a euphemism for sotto voce deregulation.

When a handful of Senate Democrats joined with Republicans to pass S. 2155, they voted to give the Federal Reserve a wide purview to tailor enhanced prudential standards on a variety of fronts for banks between $100 and $250 billion in assets.  These pillar revisions include changing the approach to company run stress tests, living wills, and liquidity requirements.

Faced with congressional questioning about how he would customize supervisory standards, Quarles highlighted four key risk profiles for supervisory standards on an individual bank– size, complexity, interconnectedness, and character of bank portfolios. In a rare case of a GOP-led Senate bill ceding authority to the Fed, S. 2155 gives the Fed sweeping discretion to tailor systemic risk rules set by DFA.

What’s Next?  Rules on Fed’s Radar

In his testimony, Quarles hinted more deregulation is on the way at the Fed.  Before the HFSC, Quarles attacked the Volcker Rule, implied he would reduce the risk-based capital surcharge at some of the nation’s largest banks, and hinted that he wanted to end limits on capital distributions due to weakness in risk management at large banks. In front of the Senate, Quarles outlined his plans improve the “regulatory efficiency” of stress testing, calibrate the LCR for non-GSIBS, and enhance stress testing transparency.

While Quarles is powering ahead, S. 2155 is currently held up in the legislative progress. The bill passed a Senate floor vote more than a month ago, 67-31, but has since been held up in the House. This is because Rep. Jeb Hensarling, the outgoing Chairman of the House Financial Services Committee, is refusing to rubber stamp the legislation. For the moment, he has the backing of House Republican leadership. Negotiating with Hensarling would surely involve making the bill more deregulatory, and that would risk alienating cosponsoring Democrats and dissolving the bill’s bipartisan backing.


1st Qtr Bank Profits Break Records (Apr. 23)

Update 265 — 1st Qtr Bank Profits Break Records
But Markets Skeptical: Is an Encore in Store?

With the last of the financial sector’s quarterly earnings reports for 1Q18 trickling in, we take a look at the condition of the large and diverse financial sector in the United States.  

What we find is a sector whose largest institutions almost all report recording-breaking if circumstantial profits. Analysts and some bank executives cast doubt though on the sustainability of the performance. Still, the banks’ performance begs the $2155-dollar question: why deregulate under these conditions?




Wall Street Gets a Tax Break, Sheds Risk

The Wall Street giants emerged from the financial crisis bigger and more profitable than ever.  Over the past ten years, the three largest banks by assets — JPMorgan Chase, Bank of America, and Wells Fargo — have added more than $2.4 trillion in domestic deposits.

Net income at JPMorgan Chase, the nation’s largest bank by assets and deposits, rose 35 percent to $8.71 billion.  Corporate tax cuts helped the six largest U.S. banks produce a combined net income that surpassed $30 billion for the first time ever.  The new corporate tax rate has saved the six largest banks about $2.9 billion thus far, contributing a ten percent increase in quarterly net profit.  The tax cuts are supposed to spur economic activity, such as lending and hiring. But loans at the four largest commercial lenders fell $2.5 billion last quarter and the combined loan count was below where it was a year earlier.

Can Wall Street Repeat?

The financial sector’s earning season that just ended makes clear the condition of its largest institutions, measured by annual profits. Along with the massive tax savings, the main factors behind Wall Street profits over the last 12 months have been:

• Trading Activity:  Trading revenue was the highest in three years as they capitalized on volatile equity markets.  Volatility in the markets came in and helped the equity trading. In particular, equity derivatives benefited Bank of America and others. Rising interest rates fueled revenue derived from lending.  Equity trading led, with every investment bank blowing past expectations in the most volatile quarter in years — even with U.S. stocks seeing the worst single-day plunge in almost seven years in early February.

• Interest Income: JPMorgan, Bank of America and Citigroup benefited as the Federal Reserve raised rates twice in the past four months, meaning they can charge more for loans.  All three firms posted higher net interest income in the first three months of the year, which they attributed to higher rates and loan growth.

• FinTech: Customers’ increasing acceptance of digital products and tools. Before online and mobile banking became popular, consumers generally opened a new account at the bank with the nearest branch; with more banking transactions done online or through smartphones, customers are picking national banks because of their well-known brands and the perception that their technology products are superior.

• Credit Quality: Credit quality remains a top concern for investors as Federal Deposit Insurance Corp. (FDIC) data shows credit-card loans reached a record last year. Bank of America and JP Morgan Chase both saw write-offs climb about eight percent, attributing the increase to souring credit-card loans. Citigroup warned that its cost of credit will likely increase in the current quarter. Regardless, all of the banks say consumer credit quality is holding up well amid low unemployment.  JPMorgan had to set aside more money to cover potentially bad loans, and the bank’s total charge-off rate — the percentage of loans it expects are not likely to be repaid — climbed to 1.20 percent of all loans. That compares to 1.07 percent of loans in 2Q17.

The following might put the profit margins on Wall Street in perspective. Wells Fargo announced a one-off write-down last week of $800 million to cover losses associated with its settlement with regulators. The firm’s tax savings from the first quarter alone came to $636 million, 80 percent of Wells’ settlement charge.
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Can Wall Street repeat this performance?  Citigroup Chief Financial Officer John Gerspach said last week that businesses had only begun taking advantage of the changes: “I think the best is yet to come.”

Community Banks Profitability Also Up

Having locked in long term loans at favorable interest rates, big banks have also taken steps to move risk off of their balance sheets.  As a result of this interest rate environment and competitive lending conditions, riskier assets have moved further down the industry as smaller, mainstreet financial institutions have “reached for yields.”

At first glance, the nation’s 5,700 community banks, with nearly $5 trillion in assets and record profits, appear to be as healthy as they have ever been.  Despite record profits, there is evidence suggesting some community banks are distributing lower quality loans in search of higher yields.

Some analysts are concerned that this combined with dangerous mortgage loans could increase risk in the community banking sector.  A provision in S.2155, the Economic Growth, Regulatory Relief, and Consumer Protection Act, would grant relief for banks with under $10 billion from the Volcker Rule and Qualified Mortgage safe harbor, opening the door for community banks to make riskier mortgage loans. The good news is that while individual banks may overextend themselves, community banks pose far less systemic risk than their larger counterparts.

Regional Bank Euphoria

While fewer than ten regional banks have announced their first quarter 2018 earnings reports, the results have been favorable for these institutions thus far. Comerica and KeyCorp each reported substantial increases in adjusted net income year over year. Northern Trust’s Q1 earnings totaled $381.6 million vs. $276.1 million the year prior. BB&T’s quarterly earnings are up 22 percent, compared to 4Q17.

Some institutions will see some short-term pain in exchange for long-term gain with the recognition of past tax deferrals. For instance, BMO Financial’s 1Q18 net income fell 35 percent due to the revaluation of its deferred tax asset of $425 million. This upfront charge will be more than worth it for BMO going forward as the company can now claim a significantly decreased tax rate.

If it passes the House, S.2155 is one of the biggest gifts the regional banking sector could have asked for. In raising the threshold for automatic enhanced prudential standards from $50 billion to $250 billion, the bill would allow regional banks to devote fewer resources to maintaining required capital buffers, complying with stress testing, and submitting resolution plans. In the short term, this will benefit these banks, but increased systemic risk could harm the financial system in the medium to longer term. Regional banks tend to have similar balance sheets, so while profit is strong at present, this class of banks rises and falls together.

The Sectoral Landscape 

The U.S. financial sector is far more stable than it was a decade ago.  Record profits, bolstered by the Republican corporate tax cut, do not appear to hide the same kind of asset bubbles, no-doc lending practices, and others risks that accompanied but went largely missed or ignored in the run up to the 2008 crisis.

The strength and stability of the financial system is thanks in no small part to post-crisis regulations. But industry lobbyists are presently hard at work taking aim at Dodd-Frank’s systemic risk protections via S.2155.

Even regulators themselves — the steadily increasing number of Trump-appointed ones at least — are not so much diligently applying lessons learned but are designing new federal rules to relax critical capital buffers, the leverage ratio, and stress testing.

More to come this week.

GOP Double-Down Hair-Doo (Apr. 17)

Update 264 — GOP Double-Down Hair-Doo:

Liked the Tax Cut?  How about a Perm?
While today marks the last day Americans will file their taxes under the old tax code, a number of Americans have already seen their paychecks influenced by lower tax withholdings.  Republicans wasted little time celebrating the Tax Cuts and Jobs Act (TCJA) before turning to tax reform 2.0 — the next round of tax cuts.
On the theory that nothing succeeds like success, the GOP seems to be staging a sequel.  What does entail substantively and will Americans want to see this movie again. And again…?




Tax Cuts Round Two

Lead by Rep. Mark Meadows, Chair of the House Freedom Caucus, Republican leadership is grating up a “phase two” of tax slashing in anticipation of the upcoming midterm elections.  This tax cut 2.0 is likely to be rolled out on two fronts: individual permanence and the indexing of capital gains.

Individual Permanence

The TCJA was a massive restructuring of the American tax code that significantly cut corporate taxes and provided more modest relief for individual filers.  Because no Democrats could be sold on it, the GOP had to pass the tax Act along party lines through the reconciliation process. Using reconciliation required tax drafters to adhere to the Byrd rule and ensure that their legislation did not add to the deficit beyond a ten-year window.

Making the individual tax cuts permanent would cost approximately $1.5 trillion in the decade after 2025.  Republicans hope this maneuver will put Democrats in an awkward position come November, because allowing the cuts to expire in 2025 would see the bottom 80 percent of income earners paying higher taxes than if the law had never passed in the first place (see more below).  This is a dangerous political game, however, as such a ploy would double the cost of the TCJA and further balloon the deficit.

Indexing Capital Gains

Beyond individual rate permanence, Republicans also seek to reduce the capital gains rate in a second round of tax cuts.  One initiative spearheaded by Sen. Ted Cruz would deflate capital gains for inflation. GOP lawmakers have long sought to slash the capital gains rate in the name of increasing investment.  But Trump railed against the preference on the campaign trail. National Economic Council Director Larry Kudlow has gone so far as to argue that the President could index capital gains via executive order.

Such an effort would only serve to make the Republican tax reform effort less equitable. According to the Tax Policy Center, nearly two-thirds of the gains from the Tax Cuts and Jobs Act will accrue to the top 20 percent of earners.  Increasing the preference on capital gains will double down on this upward redistribution because nearly 70 percent of all capital gains income is claimed by households making at least $1 million.

Gratuitous, if Deficit-Financed, Stimulus

CBO estimated this month that the country will hit trillion-dollar annual deficits by 2020, mostly thanks to Republican tax efforts and the recently passed omnibus.  Many economists view this level of stimulus as risky given where we are in the business cycle. The Fed is likely to continue to raise interest rates as the unemployment rate hits four percent, and rising debt combined with rising interest rates means rising interest costs.

The GOP has already started deflecting blame for its fiscal profligacy, with House Ways and Means Chair Kevin Brady claiming that “we don’t have a revenue problem in Washington, we have a spending problem.”  Brady then pointed to entitlement spending as an example of out-of-control spending, an indication that Republicans plan on making the middle class pay for their tax cuts twice – straddling future generations with huge deficits, and contemporary ones with entitlement cuts.

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Politics of Tax 2.0

GOP Fecklessness — This new round of tax cuts is additional evidence of a fundamental truth: it is in the Republican DNA to cut taxes.  The GOP has shown that its fiscal hawkishness during the Obama administration was nothing more than a political ruse.  Since assuming power they championed tax legislation that will increase the debt by $1.5 trillion over a decade and next negotiated a spending Act that will bring the deficit to $1 trillion in the next fiscal year.  All told CBO expects the debt to balloon to $33 trillion by fiscal 2028.

Legislation in the Works — Legislation to make individual rate cuts permanent has been introduced in both houses.  Senator Ted Cruz introduced a Senate bill to this effect, while Congressman Rodney Davis introduced a House version that makes pass-through rates permanent in addition to individual rates.  Republicans will use this legislation to chide Democratic candidates who decried the fact that the TCJA’s made corporate cuts permanent while setting individual cuts expiration date at 2025.  GOP leadership will suggest this is the Democrats’ opportunity to support making individual rates permanent. Don’t expect Democrats to bite.

The Democrats’ Take — Democrats are currently not going to support anything that does not fix more fundamental problems with the TCJA.  As Rep. Lloyd Doggett, member of the Ways and Means Committee, stated, the Republican proposals only “will make this debt situation even worse.” Senate Democrats have introduced legislation to roll back major parts of the TJCA.

Tax Plays Into Midterms

The push for a second round of tax cuts is nothing more than a political re-run in an election year.  As in the first round, Republicans did not involve Democrats in these talks. While they did not need Democratic support to pass the original TCJA, they need 60 votes this time around – a threshold they surely will not clear.  In short, Republicans always knew individual rate cuts would expire while corporate cuts would be permanent.

Nevertheless, polling trends indicate Democrats should prepare for the tax cuts’ growing popularity.  In December, the TCJA polled poorly, with just 33 percent approving. By January, that figure had increased to 46 percent approving somewhat or strongly.  February polls revealed a shrinking Democratic lead in generic Congressional control surveys alongside approval ratings for the TCJA reaching over 50 percent.  Since February, approval for the Act has leveled off marginally, with just four in ten Americans saying they like it.

By reopening the tax debate, Republicans run the risk of suffering the consequences after a winter where they were viewed as doing the bidding of the wealthiest.  It is hard to know which direction public opinion on taxes will go after tax day, but as always, but it is unlikely the Act will be resoundingly popular and a fair chance it may be associated with voters with entitlement reform and retirement insecurity.