July 13, 2017
Senate Banking Committee: The Semiannual Monetary Policy Report to the Congress
Key Topics & Takeaways
- Housing Finance: Chairman Crapo asked Yellen if she agreed with the principles for housing finance reform that Federal Reserve Governor Jay Powell outlined in remarks he gave on July 6. Yellen said she agreed with those principles, which were: 1) reduce the possibility of future bailouts; 2) make any government guarantee explicit and transparent; 3) increase competition in securitization; 4) use existing regulatory and market infrastructure; and 5) Congress should build on areas of bipartisan support. Yellen agreed with Crapo that Congress needs to act to end the receiverships of Fannie Mae and Freddie Mac.
- Orderly Liquidation Authority: Sen. Van Hollen asked Yellen about the importance of preserving the Orderly Liquidation Authority (OLA). Yellen said that it is “essential” that an orderly liquidation mechanism exist, saying that the inability of regulators to quickly resolve non-depository institutions during the financial crisis increased the severity of the crisis. Yellen did concede that bankruptcy should be the preferred route for resolution, but argued that OLA is an important safeguard due to the inability of regulators to predict the circumstances around the collapse of a major financial institution. Yellen also stressed the importance of living wills as a supplement to any resolution process.
- Volcker Rule: Crapo noted that Fed Governor Powell recently said the Fed was reviewing the Volcker Rule, and asked Yellen to elaborate on the Fed’s review of the rule. Yellen said that any review of the Volcker Rule should be a multi-agency effort and that steps should be taken to reduce the rule’s complexity. Crapo asked Yellen if she supported having a lead regulator appointed to deal with this issue, and Yellen said that Congress should consider the question.
- The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System
Chairman Mike Crapo (R-Idaho) began his opening remarks by stating that economic growth is the top priority for the Senate Banking Committee and for Congress. He explained that the committee has received thousands of letters from many different communities in the United States regarding the economy. He then listed some issues that he believes need to be addressed, such as the systemically important financial institution (SIFI) threshold, the Volcker Rule, and the rules on capital for small banks. Crapo then stressed the difficulty of his constituents in accessing business loans and stated that it hinders job creation and economic growth. Next, Crapo expressed the need for changing the $50 billion SIFI threshold, and then continued to list the many qualified people in agreement with him, including acting chairman of the Office of the Comptroller of the Currency (OCC) Keith Noreika. Additionally, he mentioned the problems with the current housing finance system and how it fails to serve in the best interest of “consumers, tax payers, lenders, and the broader economy.” Lastly, Crapo raised concern for the continuously growing interest rates produced by the Federal Reserve.
Ranking Member Sherrod Brown (D-Ohio) began by mentioning the Federal Reserve’s plans to sell the last of its securities purchased during the financial crisis. Consequently, he stressed the fact that banks made “record profits” this year, and passed the most recent stress tests. However, he explained that the rules and regulations put in place after the crisis should not be forgotten just because of the recent Wall Street success. He brought attention to the middle- and lower-class families that still feel the effects of the financial crisis today, and how they should not be ignored. Additionally, he raised concern for the direction the Trump administration is going regarding the recent pro-Wall Street nominations. Lastly, Brown expressed the importance of achieving long-term economic growth that “lifts up all Americans.”
The Honorable Janet L. Yellen, Chair, Board of Governors of the Federal Reserve System
In her testimony, Yellen said that since her last testimony before the committee, the labor market has strengthened, job gains have averaged 18,000 per month, the unemployment rate has fallen a quarter percentage, and the labor force participation rate has not significantly changed. She stated that going forward, favorable financial conditions coupled with the prospect of continued foreign and domestic spending gains should continue to support business investment, and the economy will “continue to expand at a moderate pace over the next couple of years, with the job market strengthening somewhat further and inflation rising to two percent.”
Yellen addressed current monetary policy, stating that the Federal Open Market Committee (FOMC) will continue to foster maximum employment and price stability as required by law. Yellen said the FOMC will adjust their assessments of the appropriate path of the federal funds rate in response to changes in the economic outlook and to their judgments of the associated risks. Addressing the Fed balance sheet, Yellen highlighted that the FOMC provided additional details on the process the Fed will follow to normalize the size of the balance sheet, including reducing the Federal Reserve’s security holdings by decreasing its reinvestment of the principal payments it receives from the securities held in the System Open Market Account. Yellen highlighted that the committee intends to change the target range for the federal funds rate as a primary means of adjusting the stance of monetary policy, and does not intend to use the balance sheet as an active tool for monetary policy. Yellen stated they are committed to using the “full range of tools” at their disposal, however, if future economic conditions warrant a more accommodative monetary policy.
Question & Answer
Crapo asked Yellen if she agreed with the principles for housing finance reform that Federal Reserve Governor Jay Powell outlined in remarks he gave on July 6. Yellen said she agreed with those principles, which were: 1) reduce the possibility of future bailouts; 2) make any government guarantee explicit and transparent; 3) increase competition in securitization; 4) use existing regulatory and market infrastructure; and 5) Congress should build on areas of bipartisan support. Yellen agreed with Crapo that Congress needs to act to end the receiverships of Fannie Mae and Freddie Mac.
Federal Reserve Balance Sheet
Crapo noted that the last time Yellen appeared before the Senate Banking Committee, she said she wanted to reduce the Fed’s balance sheet and make it primarily Treasury securities. Crapo asked if the Treasury security holdings would be wound down faster than the mortgage-backed securities (MBS) holdings. Yellen confirmed this, saying that the Fed will wind down MBS but at a slower rate than Treasuries. Yellen reaffirmed her commitment to moving the balance sheet to be based mainly on Treasuries.
Sen. Tim Scott (R-S.C.) asked Yellen if she could provide a timeline for winding down the balance sheet and if there is a target number for its size. Yellen declined to provide a specific timeline, and repeated her previous statements that the unwinding would be slow, gradual, and predictable. Yellen said that the Fed’s priority is to not disrupt financial markets, and that the balance sheet would not be shrunk down to its pre-crisis size.
Sen. David Perdue (R-Ga.) also asked about the Fed’s plans for its balance sheet after winding down assets, and Yellen said that while the balance sheet will shrink “considerably,” it remains to be seen what the final size of the balance sheet will be.
Crapo noted that Fed Governor Powell recently said the Fed was reviewing the Volcker Rule, and asked Yellen to elaborate on the Fed’s review of the rule. Yellen said that any review of the Volcker Rule should be a multi-agency effort and that steps should be taken to reduce the rule’s complexity. Crapo asked Yellen if she supported having a lead regulator appointed to deal with this issue, and Yellen said that Congress should consider the question.
Financial Regulatory Reform
Crapo asked Yellen if she agreed that Congress should take action to change the $50 billion SIFI threshold and the Volcker Rule, exempt some companies from stress tests, and reduce the burdens on community banks and credit unions. Yellen thought it would be appropriate for Congress to act in these areas. Crapo asked Yellen to provide the Senate Banking Committee with any ideas for legislation the Federal Reserve has.
Sen. John Kennedy (R-La.) asked about the efficiency of the Volcker Rule. Yellen said that she supports the general idea behind the rule, but explained that there are many flaws. She stated that community banks should be exempt entirely and that the implementation has been far too complex.
Sen. Mike Rounds (R-S.D.) asked Yellen about enhanced supplemental leverage ratio (SLR) and if she could provide a timeframe for when it may be done. Yellen replied that the Fed is aware of issues faced by custody banks and is why they are looking at appropriately calibrating enhanced SLR for them, adding that other countries have taken different approaches. She would not commit to a timeframe but stressed that they are “looking at it carefully.”
Capital and Liquidity Requirements
Brown asked Yellen if she thought the post-2008 regulatory architecture is necessary to prevent another financial crisis. Yellen said that the post-crisis financial reforms have increased the stability and resiliency of the financial sector, though this does not mean another crisis will never happen. Yellen said that stronger capital and liquidity requirements and stress testing have decreased risk in the financial sector and increased the chance that, even in a significant economic downturn, banks will be able to function and provide for the credit needs of the economy. Yellen said it is important to keep in place these post-crisis reforms and that she is not in favor of reducing the capital requirements “for the most systemic banks.” Yellen said, “there are many things in the Treasury report that [she] agrees with” and that the Fed is working to tailor regulations for certain financial institutions, but for systemically important banks it is “critically important” to maintain the existing capital standards.
Brown asked if the Fed is on track to finish changes to adding additional capital surcharge under the large bank stress tests. Yellen replied that the Fed is “working hard on them” but would not guarantee that they will be in place for next year’s stress tests.
Sen. Chris Van Hollen (D-Md.) noted that some have proposed eliminating the leverage ratio or capital buffer, while others have agreed that maintaining both ensures safety in the financial system. Yellen agreed with the latter, explaining that both need to be in place and calibrated appropriately.
Sen. Mark Warner (D-Va.) asked if there is value in keeping the Comprehensive Capital Analysis and Review (CCAR) in place for the largest institutions. Yellen replied that stress tests and CCAR have “substantially” strengthened the largest firms, and that the Fed is looking at CCAR carefully to determine if changes are needed.
Sen. Bob Corker (R-Tenn.) raised concern about the low productivity growth in the United States. He asked Yellen if she thought tax reform would be a proper solution to the issue. She answered that yes, tax reform could have a positive effect on the economy but it depends on the detail of the plan. She expressed that the “distortions” in the tax code have a significant impact on productivity growth.
Corker then moved on to explain that constraining government spending should be a top priority and stated that growth would help solve the issue. He mentioned that the Trump administration was hoping to raise the gross domestic product (GDP) growth to three percent, and asked Yellen if this was even possible. Yellen responded by stating that it is possible, but extremely difficult.
Sen. Heidi Heitkamp (D-N.D.) echoed Corker’s question of the uncertainty of the projected GDP growth by the Trump administration. Additionally, she stressed the importance of working together with Yellen to create a thoughtful strategy to achieve the three percent growth goal.
Kennedy asked Yellen how she would attempt to raise the GDP growth from two percent to three percent. She responded by stating that Congress is responsible for making those decisions, not the Federal Reserve. However, her advice was to focus on all the factors that determine productivity growth. Some examples she mentioned were tax reform, education, public and private investment, and attention to technological change.
Heitkamp stressed concern for the commodities industry in the United States, as her state, North Dakota relies heavily on commodity trading. She asked Yellen if she believed that trade policy is critical to economic growth. Yellen said it has been in the past, but gave no further comment on the subject.
Kennedy asked Yellen if moving away from the Glass-Steagall Act was a mistake. She answered that she did not believe Glass-Steagall was responsible for the financial crisis, and does not see it as a major issue at all.
Consequently, Kennedy asked if she believed it contributed at all in the crisis, or if it was irrelevant. Yellen agreed that the biggest contributor to the crash was the stand-alone investment banks, but stated that the regulations that followed the crisis are effective in ensuring safety and security.
Warner stated that many financial transactions have moved into the shadow banking system and asked where vulnerabilities may be. Yel, as risk can “move outside” the regulatory perimeter, but that she did not have anything specific to highlight.
Orderly Liquidation Authority (OLA)
Van Hollen asked Yellen about the importance of preserving the Orderly Liquidation Authority (OLA). Yellen said that it is “essential” that an orderly liquidation mechanism exist, saying that the inability of regulators to quickly resolve non-depository institutions during the financial crisis increased the severity of the crisis. Yellen did concede that bankruptcy should be the preferred route for resolution, but argued that OLA is an important safeguard due to the inability of regulators to predict the circumstances around the collapse of a major financial institution. Yellen also stressed the importance of living wills as a supplement to any resolution process.
For more information on this hearing, please click here.