September 12, 2017
House Financial Services Subcommittees on Financial Institutions and Consumer Credit & Monetary Policy and Trade “Examining the Relationship Between Prudential Regulation and Monetary Policy at the Federal Reserve”
Key Topics & Takeaways
- Systemically Important Financial Institutions (SIFIs): Rep. Blaine Luetkemeyer (R-Mo.) asked if SIFIs should be designated using a risk-based model rather than the current $50 billion in assets threshold. Barnett Sivon & Natter’s Sivon agreed and noted his support for Luetkemeyer’s H.R. 3312, the Systemic Risk Designation Improvement Act of 2017, which would designate SIFIs based on risk methodology, adding that the legislation is a “more constructive and tailored approach” than the current threshold.
- Volcker Rule: Rep. Robert Pittenger (R-N.C.) stated that the Volcker Rule has “immense complexities” and prevents small and medium companies from expanding their business, and asked what Congress should do. Sivon replied that there were concerns the Volcker Rule would impact liquidity when it was contemplated, including studies the Fed conducted, and recommended that the rule be revisited and not be applicable for smaller businesses. He continued that the Fed should coordinate with the other regulatory agencies to streamline the issues. Columbia University’s Calomiris added that there should be a discussion about “fixing regulations that aren’t credible, like Dodd-Frank.”
- Stress Tests: Sivon suggested that stress test scenarios be published for public comments. Calomiris argued that stress tests are “close to useless as a forecasting tool for the sudden loss of economic value,” adding that the scenarios in the tests “aren’t very meaningful.” He continued that while he is not opposed to stress tests, “they aren’t currently ready for prime time.” Brandeis University’s Ceccheti argued that the Fed is trying to improve their stress test models, but warned about people “gam[ing] the system” if there is too much transparency.
- Dr. Charles Calomiris, Henry Kaufman Professor of Financial Institutions, Columbia Business School, Columbia University
- Dr. Stephen G. Cecchetti, Rosen Family Chair in International Finance, Brandeis International Business School, Brandeis University
- Jim Sivon, Partner, Barnett Sivon & Natter P.C., on behalf of the Financial Services Roundtable
Rep. Andy Barr (R-Ky.), Monetary Policy and Trade Subcommittee Chair
In his opening statement, Barr noted that the hearing will discuss whether the monetary policy and supervisory responsibilities of the Federal Reserve (“Fed”) conflict with each other, saying that if either does not work, “the economy doesn’t work.” He continued that last quarter had three percent gross domestic product growth, which is a “good start,” but that to continue such growth monetary policy and financial regulations must be organized.
Rep. Gwen Moore (D-Wis.), Monetary Policy and Trade Subcommittee Ranking Member
Moore stated that the Fed is the systemic regulator of the financial system and acts as a lender of last resort, so it “makes sense” for the Fed to have supervisory functions over financial institutions.
Rep. Blaine Luetkemeyer (R-Mo.), Financial Institutions and Consumer Credit Subcommittee Chair
Luetkemeyer criticized the Fed for providing “little to no feedback” when it comes to supervision, and that their regulatory regime “doesn’t translate to a more stable economy.” He later questioned whether it is appropriate for the Fed to be a prudential regulator and “sole dictator” of monetary policy.
Rep. Brad Sherman (D-Calif.)
Sherman questioned why the New York Federal Reserve gets a seat on the Federal Open Market Committee (FOMC) but not California. He then criticized the financial system for not providing enough capital to small businesses, forcing them into shadow banking, and states that more quantitative easing (QE) is needed.
Dr. Charles Calomiris, Henry Kaufman Professor of Financial Institutions, Columbia Business School, Columbia University
In his testimony, Calomiris criticized the Fed for being “more politicized than ever before,” and that it is “less independent than almost any other time” when it comes to their supervisory role and monetary policy. He continued that the leaders of the Fed give “distorted opinions” on regulatory reform proposals, that a set of rules to guide monetary and regulatory policy are needed to avoid conflicts of interest, as well as the establishment of administrative and budgetary discipline. Calomiris concluded that Congress must assist with creating such rules, and that only then would it be possible for the Fed to retain both their monetary policy and supervisory roles.
Dr. Stephen G. Cecchetti, Rosen Family Chair in International Finance, Brandeis International Business School, Brandeis University
In his testimony, Cecchetti explained that “strict regulations” have led to progress when it comes to the largest banks meeting stress tests and being “less likely to become a burden on taxpayers,” and that the progress must continue. He made two points: 1) that the Fed’s prudential supervision must be an independent function, with an independent budget; and 2) due to the Fed being the central bank, they should remain the lead supervisor for financial institutions. Cecchetti explained that the Fed’s supervision is “critical” in being the lender of last resort, as they need to be able to determine solvency, conduct confidential financial assessments, and have a knowledge of a bank’s business practices. He concluded that it is “essential” for the Fed to continue being the lead supervisor for systemically important financial institutions (SIFIs), and noted that when financial supervisors are “independent of political interference and have budget autonomy,” the financial system is more stable.
Jim Sivon, Partner, Barnett Sivon & Natter P.C., on behalf of the Financial Services Roundtable
In his testimony, Sivon explained that since the financial crisis, bank holding companies (BHCs) have increased capital levels, but that some regulations are “holding back a more robust recovery.” He offered several recommendations: 1) capital planning and stress testing rules should be adjusted, to include the comprehensive capital analysis review (CCAR); 2) tailor the capital and liquidity rules, to include adjusting the supplemental leverage ratio (SLR) and revising the capital surcharge; 3) coordination between resolution and recovery planning requirements; 4) tailor prudential standards for insurance companies; 5) review model validation and vendor management standards; and 6) revisit the Volcker Rule.
Question & Answer
Politicizing the Fed
Barr asked if monetary policy and financial regulations would be better if the Fed had more independence and accountability, to which Calomiris responded “absolutely.” Calomiris explained that the Fed uses regulatory policy as a “sacrificial lamb” to make deals and preserve monetary policy autonomy, but it would not be needed if monetary policy followed rules. He continued that Operation Choke Point was a “disgrace” and that it was “clear” the Fed was under political pressure. Calomiris added that subjecting the Fed to the appropriations process would “absolutely” help with the politicization.
Rep. Keith Rothfus (R-Pa.) asked if the Fed’s balance sheet raises a conflict of interest for their regulatory work. Calomiris explained that it creates “multiple” conflicts of interest, and gave the SLR as an example of how the Fed has profited due to being a competitor in the repo market.
Rep. Tom Emmer (R-Minn.) discussed the number of community banks that have been “lost” since Dodd-Frank, adding that new banks are not being created, and asked if there is Fed favoritism towards the larger financial institutions. Calomiris explained that some regulations are “hitting” the larger institutions, but that many are also “hitting” the smaller institutions, and that the problem is that smaller companies are unable to spread the overhead cost of complying with the regulations.
Moore, Rep. David Scott (D-Ga.) and Rep. Bill Foster (D-Ill.) questioned how subjecting the Fed to the appropriations process would make them more independent. Cecchetti argued that it does not and that one of Basel’s principles for effective supervision is budget independence. He continued that it is “difficult to understand” how giving Congress control of the Fed’s budget would improve their independence.
The Role of Central Banks
Moore noted that the role of central banks is being challenged globally, to which Cecchetti replied that the Fed’s lender of last resort function relies “heavily” on supervisory information about the safety and soundness of financial institutions, and that if such lending is done outside of the central bank, there would be a need for some sort of shadow central bank.
Luetkemeyer noted the list of federal agencies that rules should be applicable to in the June Treasury Report, to which Sivon responded that it is a good synopsis of how regulatory coordination should be carried out. Sivon continued that the Core Principles laid out in Executive Order 13772 provide a guide for the regulatory overarching.
Luetkemeyer asked if SIFIs should be designated using a risk-based model rather than the current $50 billion in assets threshold. Sivon agreed and noted his support for Luetkemeyer’s H.R. 3312, the Systemic Risk Designation Improvement Act of 2017, which would designate SIFIs based on risk methodology, adding that the legislation is a “more constructive and tailored approach” than the current threshold.
Current Expected Credit Loss (CECL) Standard
Luetkemeyer and Rothfus asked about CECL and what impacts there may be with implementation of the CECL standard. Sivon replied that it is a fundamental accounting change that would require financial institutions to forecast what may happen with the economy, adding that it would be difficult with long-term items (such as a 30-year mortgage).
Supervisory and Monetary Policy Roles
Financial Institutions and Consumer Credit Subcommittee Ranking Member Wm. Lacy Clay (D-Mo.) asked the panel to comment on how the Fed collecting standardized data from the largest financial institutions would help inform the Fed’s policy making role. Calomiris noted that there are deficiencies in the data that must be remedied, and argued that the Fed’s stress tests are built on “old data.” Cecchetti argued that the Fed must be able to measure aggregate systemic risk and how it is distributed, which requires more exposure information from intermediaries than the Fed is currently getting. Sivon agreed with Calomiris, adding that he would like to see data released on an aggregated basis.
Rep. David Scott (D-Ga.) asked if the Fed would be ill-equipped to be the lender of last resort if their regulatory oversight and monetary policy were separated. Cecchetti replied that it is important the central bank can make loans to banks, but that it is also important they not make loans to institutions that are already bankrupt, as it is “basically a bailout.” He continued that the only want to make sure the Fed does not make such loans is to have the supervisory information they have as the central bank. Scott then noted that the lender of last resort is the “welfare of the entire economy,” adding that there would be “devastating turbulence” should this be taken from the Fed.
Supplemental Leverage Ratio
Rothfus noted challenges with the SLR’s calculation, adding that he introduced H.R. 2121, the “Pension, Endowment, and Mutual Fund Access to Banking Act,” to address excluding risk-free assets from SLR. Sivon stated his support for the legislation, noting that he would like to see it expanded to all banks, as risk-free assets should not be counted as part of the ratio.
Rep. Robert Pittenger (R-N.C.) stated that the Volcker Rule has “immense complexities” and prevents small and medium companies from expanding their business, and asked what Congress should do. Sivon replied that there were concerns the Volcker Rule would impact liquidity when it was contemplated, including studies the Fed conducted, and recommended that the rule be revisited and not be applicable for smaller businesses. He continued that the Fed should coordinate with the other regulatory agencies to streamline the issues. Calomiris added that there should be a discussion about “fixing regulations that aren’t credible, like Dodd-Frank.”
Foster asked what the global experience has been in using contingent capital as a market-based mechanism. Calomiris replied that the demand for contingent capital instruments has been “very high” from investors, and is a promising idea. Foster added that a market-based instrument that would “warn banks two steps back has real merit,” to which Calomiris replied that he does not have faith that the Federal Deposit Insurance Corporation (FDIC) could resolve institutions.
Rep. Scott Tipton (R-Colo.) questioned the modeling of stress tests, to which Sivon explained that the models are not transparent with the industry, and that banks try to guess what the model will show and modify their loan activity as such, but that it “may not be the most appropriate.”
Luetkemeyer discussed stress test models and his concern that they do not accurately reflect what a stressful situation would be. He continued that banks are guessing what will happen with stress tests because the Fed is not transparent with the exams. Sivon replied with the suggestion that stress test scenarios are published for public comments. Calomiris argued that stress tests are “close to useless as a forecasting tool for the sudden loss of economic value,” adding that the scenarios in the tests “aren’t very meaningful.” He continued that while he is not opposed to stress tests, “they aren’t currently ready for prime time.” Ceccheti argued that the Fed is trying to improve their stress test models, but warned about people “gam[ing] the system” if there is too much transparency.
Rep. Trey Hollingsworth (R-Ind.) stated that the economy has suffered due to regulatory burdens, and Calomiris agreed, adding that small banks have been impacted the most, and that they are having to push mortgages rather than small business lending.
Hollingsworth then discussed the legislation he sponsored, H.R. 3179, the Transparency and Accountability for Business Standards Act, which would harmonize regulations across jurisdictions. Sivon voiced his strong support for the bill, explaining that it would require an agency to conduct a cost-benefit analysis before imposing any kind of standard.
Rep. Ed Royce (R-Calif.) asked if transparency has been brought to government-sponsored entities (GSEs) and the role the Fed plays in subsidizing the housing market. Calomiris stated that moral hazard has “gotten worse,” noting that there has been almost no discussion of mortgages or real estate in Financial Stability Oversight Council (FSOC) discussions. He continued that the FSOC is also politicized and will not be “honest about mortgage risk.”
For more information on this hearing, please click here.