July 18, 2018

House Financial Services Committee “Monetary Policy and the State of the Economy”

Key Topics & Takeaways

  • Volcker Rule: Powell addressed a number of issues related to the Volcker Rule, and said that for smaller institutions, they will be streamlining “quite a lot.” Asked about plans to modify the scope of the restrictions on banks’ long-term investments in covered funds, Powell replied that the proposal is out and they are “eager” to receive comments. Noting he generally does not see it as an activity that typically threatens safety and soundness.
  • SIFI Designation: Powell said that the systemically important financial institution (SIFI) designation threshold language is clear and gives the Federal Reserve the authority it needs. Asked if banks below $250 billion pose a systemic risk, Powell said institutions under $250 billion are generally simpler, less complex, and engaged in traditional banking activities, and therefore different from the larger ones.
  • GSE Reform: Powell said now is a good time to move forward on GSE reform, as it is a “big piece of unfinished business” from the financial crisis, and that it is “unsustainable” for the housing finance system to be on the government’s books.

Witness

Opening Statements

Chairman Jeb Hensarling (R-Texas), House Financial Services Committee

In his opening statement, Hensarling expressed concern that some Federal Open Market Committee (FOMC) members are calling for a slowing down or stopping the process of transitioning away from a macroprudential balance sheet, stressing that this would move the Fed into economic activities beyond its monetary mandate. Hensarling voiced some governance concerns, chief among them that the three members on the Board of Governors could set monetary policy unilaterally given that they control the interest rates on reserve deposits, which have taken the lead role in recent monetary policy. Hensarling then called upon the Senate to confirm the Trump administrations nominees for the Federal Reserve.

Ranking Member Maxine Waters (D-N.Y.), House Financial Services Committee

In her opening statement, Waters expressed concern with the policies of the Trump administration, specifically noting the current trade disputes and their effects on American consumers. She also voiced her anxiety regarding the recent tax bill, noting the increase in corporate stock buybacks and deficit increases, and asked for a discussion of what tools the Fed could use to prevent a possible recession triggered by such policies.

Rep. Andy Barr (R-Ken.)

In his opening statement, Barr noted the strength of the economy but questioned current trade policy, the Fed’s unconventional monetary policy and “bloated” asset sheet, the flattening yield curve, and out of date regulation, using the example of the global systemically important bank (G-SIB) surcharge making American banks less competitive globally.

Testimony

The Honorable Jerome H. Powell, Chairman, Board of Governors of the Federal Reserve

In his testimony, Powell defended the actions of the Federal Reserve to return interest rates and securities holdings to normal levels, citing the unemployment rate, the labor force participation rate, and inflation being near its two percent target. He noted that strong job gains, rising after tax income, and optimism among households have lifted consumer spending, which has, along with healthy levels of business investment and strong economic performance abroad, contributed to robust gross domestic product (GDP) growth in the first half of this year. The Chairman concluded that the Federal Open Market Committee (FOMC) believes that continuing to gradually raise the target for the Federal Funds Rate and reduce the Federal Reserve’s holdings of Treasury and mortgage-backed securities (MBSs) is the best path forward.

Question & Answer

Trade

Reps. Waters, Emanuel Cleaver (D-Mo.), Sean Duffy (R-Wis.), David Scott (D-Ga.), Al Green (D-Texas), Robert Pittenger (R-N.C.), and Warren Davidson (R-Ohio) asked about trade and the effects of tariffs on the economy. Powell replied that if higher tariffs are sustained for a long period of time, it will have negative effects for both the U.S. and world economy, and that a more protectionist economy is generally less competitive and less productive. Powell stated that it is too early to see an effect in the aggregate numbers, but individual companies have been harmed and the agricultural community has been particularly affected. Powell added that he was not consulted in the administration’s discussions on trade policy. Regarding China, Powell stated it is appropriate to address their trade regime.

Federal Reserve Balance Sheet

Multiple Members asked about the progress of winding down the Federal Reserve’s balance sheet. Powell stated the plan is to return to a mainly treasuries-based balance sheet, and though the estimates are uncertain as to how long that will take, he predicts it will take three to four years. Powell said the shrinking of the balance sheet will ultimately depend on the public’s demand for currency and for reserves. Powell added that he does take into consideration the affects an outsized balance sheet could have on the Federal Reserve’s independence.

LIBOR

Rep. Brad Sherman (D-Calif.) asked what the Federal Reserve will do to ensure the new benchmark does not increase mortgage bargaining or disrupt the mortgage market. Powell replied that many mortgages reference the London Interbank Offered Rate (LIBOR), and it is a rate that is under a lot of pressure and may not be there in three or four years. Powell said they have identified a backup, which is not designed to represent an increase in mortgage costs, but rather to represent a more sustainable, predictable, and reliable rate that will be just as good for derivatives as for mortgages.

Volcker Rule

Rep. Bill Huizenga (R-Mich.) expressed concerns with the Volcker Rule, and asked about proposed reforms to simplify and clarify the regime. Powell said that for smaller institutions, they will be streamlining “quite a lot.” Powell noted they want to stay faithful to Congress’s intent, and the proposal is out for public comment. Huizenga asked if the new proposal to use accounting rules to identify proprietary trading could result in more activities getting caught up in the Volcker regime. Powell said that was not the intent and it will be given “careful consideration.”

Rep. Frank Lucas (R-Okla.), Rep. Randy Hultgren (R-Ill.), and Rep. Ted Budd (R-N.C.) asked about covered funds and if the Federal Reserve has plans to modify the scope of the restrictions on banks’ long-term investments. Powell replied that the proposal is out and they are “eager” to receive comments. Powell noted they are bound by the statute, but generally do not see it as an activity that typically threatens safety and soundness, so would be willing to work within the statutory language and intent to address it.

TCJA

Moore asked about the impact of H.R. 1, the Tax Cuts and Jobs Act (TCJA), on economic growth, noting that many companies are pursuing stock buybacks. Rep. Stivers also asked about stock buybakcs. Powell said that fiscal policy has been on an unsustainable path, and the economy needs to grow faster than the debt. Powell noted that when companies decide to buyback stocks, it means they have more cash than they can put to work for shareholders.

Pittenger asked about the effects of the TCJA on the labor market, to which Powell replied they continue to see it strengthen, and hope those gains are sustained. Pittenger also asked about the effects of the TCJA on monetary policy decisions. Powell stated it is difficult to single out, but they are examining the full economy.

SIFI Designation

Rep. Blaine Luetkemeyer (R-Mo.) asked if the systemically important financial institution (SIFI) designation threshold language is clear. Powell replied that the language is “very clear” and gives the Federal Reserve the authority it needs.

Rep. Keith Rothfus (R-Pa.) said that setting the $250 billion SIFI designation threshold grouped large regional banks together with banks with assets in excess of $1 trillion, noting that these banks differ in their risk and complexity. Powell agreed that there are differences, and they are working on a framework to address this. Powell added that he supports an activities-based approach for non-bank SIFI designation.

Rep. Barry Loudermilk (R-Ga.) asked if banks below $250 billion pose a systemic risk. Powell noted that one of the eight SIFI’s is under $250 billion because of the nature of its activities. Powell said institutions under $250 billion are generally simpler, less complex, and engaged in traditional banking activities, and therefore different from the larger ones. Powell added that they will publish a framework for how they look at risk and safety and soundness, receive comment, and move forward.

  1. 2155

Luetkemeyer asked how long it will take the Federal Reserve to implement S. 2155. Powell said certain aspects are already in motion, and with regards to SIFI designation, they are thinking through the framework and how they will put it out for public comment. Scott noted that S. 2155 gave the Federal Reserve authority to tailor regulations for regional banks and asked if Powell’s vision is a set of enhanced prudential regulations for SIFIs different from those for G-SIBs. Powell replied that they will develop and put out for comment a framework they will use to assess the financial stability and the safety and soundness risks of those institutions, then move forward. He noted that he anticipates many of the factors used to identify SIFIs will also be used in this context.

Stress Testing

Luetkemeyer asked if stress testing programs should be moved back into the normal exam cycle. Powell responded that they are looking at moving the qualitative portion of the test into the regular exam cycle, and are looking for the right way and time to do so. Powell also noted they are working to make the test more transparent.

Cybersecurity

Rep. Jim Himes (D-Conn.) asked Powell to address cybersecurity risks for financial stability. Powell said while there is a “good playbook” for monitoring a number of other risks to the financial system, the threat of a successful cyber attack is worrisome. Powell said Congress should address cybersecurity, and though the Federal Reserve does “a great deal,” there is much more to be done. Powell added they also “plan for failure” in the event of a successful attack. Stivers also asked about cyber risks.

GSEs

Rep. Ed Royce (R-Calif.) asked about government sponsored entity (GSE) reform. Powell said now is a good time to move forward on GSE reform, as it is a “big piece of unfinished business” from the financial crisis. Powell said it is “unsustainable” for the housing finance system to be on the government’s books. Powell also noted he hopes that the GSEs would ideally not present systemic risk.

Money Market Funds

Royce asked if Powell has concerns about reversing rules for money market funds and the floating net asset value (NAV). Powell said it was identified as a “critical weakness” in our financial system during the crisis, it was addressed, and he would not like to see that undone.

SA-CCR

Hultgren asked if the Standardized Approach Counterparty Credit Risk (SA-CCR) will be implemented in the next year. Powell said the SA-CCR is a good policy, they are working on the rule, and hope it can get out in the next year.

For more information on this hearing, please click here.