- Jerome Powell, the nominee to replace Janet Yellen as Federal Reserve chair, appears to favour lighter-touch regulation of the financial sector.
- This probably endeared him to Donald Trump, who ran for president with chants of repealing the postcrisis Dodd-Frank reforms.
- Powell’s statement that banks were no longer “too big to fail” contradicts the view of many of his fellow regulators – and Wall Street’s consensus.
- The country’s three biggest banks together hold assets that amount to more than one-third of the yearly output of the US economy.
- “No one knows how the next crisis will propagate through the financial system,” says Sandeep Dahiya, a finance professor at Georgetown’s McDonough School of Business.
We’ve been speculating for a while about what it is that President Donald Trump sees in Jerome Powell, his nominee to replace Janet Yellen at the helm of the Federal Reserve (even though he’s less qualified and not a trained economist; Yellen is doing a fine job; and recent practice to maintain some predictability at the Fed is to not make changes like this).
What are some of those reasons? For one thing, Powell is a man. Also, he’s a Republican. Also, even though Trump seems intent on undoing anything his predecessor did, Powell is seen as an extension of the current Fed’s thinking and therefore a relatively safe bet sure to please record-setting stock markets.
But on Tuesday we got another explanation, and it is in fact not an extension of the Fed’s thinking. Speaking in front of the Senate Banking Committee on Tuesday, Powell offered a sense of how his worldview aligns with Trump’s.
Unlike Yellen, who has urged lawmakers to be cautious about revoking any postcrisis financial rules, Powell seemed just about ready to lobby on Wall Street’s behalf.
“We will continue to consider appropriate ways to ease regulatory burdens while preserving core reforms,” Powell, a former private-equity executive, said during his testimony. Trump has vowed to repeal the postcrisis Dodd-Frank financial rules.
Pressed by Democrats on why he saw bank regulations as a burden given the industry’s record profits, Powell demurred. Sen. Elizabeth Warren asked him which rules he would like to make more stringent, and Powell said none at all: “I think they are tough enough.”
More striking, when asked by another senator whether any of Wall Street’s largest banks, which have only become bigger since the financial crisis of 2008, were still considered too large to be allowed to go under, Powell stated categorically: “No.”
This view, which Powell had not previously expressed in public despite being a Fed governor since 2012, flies in the face of conventional wisdom, even among Wall Street firms. It also contradicts the view of many of Powell’s colleagues at the Fed and other top regulators.
‘Too big to fail’ is not over
Most vocally, Neel Kashkari, himself a former Goldman Sachs banker but now the president of the Minneapolis Fed, has argued that the problem of too-big-to-fail banks is far from over. “I believe the biggest banks are still too big to fail and continue to pose a significant, ongoing risk to our economy,” he said last year, a message he has continued to hammer home.
Kashkari is hardly alone. In May, Thomas Hoenig, the vice chairman of the Federal Deposit Insurance Corporation, another top bank regulator, told the Washington Examiner that “as much as we would like to conclude that too-big-to-fail has been solved,I don’t believe it has.”
Hoenig, a former president of the Kansas City Fed, cited “the commingling of very high-risk activities under the deposit insurance system, with the moral hazard that goes with that.” He continued: “You have these very large, complex, interconnected, undercapitalized institutions.”
Yellen has been a bit more optimistic. She says the Fed has made progress in taming megabanks considered too gigantic to go belly up through higher capital requirements that force them to rely less heavily on debt and through a new, as yet untested authority that supposedly allows the Fed to wind down a failing Wall Street firm.
But the current Fed chair, whose term ends in February, has never made so bold a claim as to say the problem is fixed. And she has been emphatic about the need for short memories not to allow a repeat of the 2008 debacle, which coincided with the worst recession in generations – one that caused the loss of some 9 million jobs.
Powell’s ‘Mission Accomplished’ moment
Just how big are the country’s largest banks? JPMorgan held total assets of $US2.5 trillion, Bank of America $US2.2 trillion, and Wells Fargo nearly $US2 trillion. Together, that amounts to more than one-third of the yearly output of the US economy, which is by far the world’s largest.
So why would Powell make such a bold claim?
Sandeep Dahiya, a finance professor at Georgetown’s McDonough School of Business, describes it as perhaps a clumsy effort to bolster the Fed’s accomplishments.
“All big banks passed the Fed stress test in 2017, and all big banks are required to submit their ‘living wills’ that outline what should happen to them in case they fail,” Dahiya told Business Insider.
However, Dahiya notes, the Fed has given extensions to the eight biggest US banks to get its approval for their living wills, so they are technically not yet fully compliant. That’s if one even believes such blueprints for how to unwind a large institution would work in a chaotic time of crisis, which many finance experts do not.
That leads to the bigger issue.
“No one knows how the next crisis will propagate through the financial system – how realistic is the scenario that the US regulators will let three or four or five of the largest banks unwind based on their living wills?” Dahiya said. “The spillover effects may be too severe, and taxpayers may still have to put a backstop to the losses of the largest banks.”
Even if we give Powell the benefit of the doubt of having made a mistake in tone, it’s still an error that suggests a dangerous level of complacency about the need for vigilant bank regulation from one of its chief stewards.
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