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Why Jay Powell has been a ‘dangerous man’ at the Fed

The writer is president of Better Markets 

In a recent hearing, Senator Elizabeth Warren told US Federal Reserve chairman Jay Powell that he is “a dangerous man” and that she would not support his renomination to head the central bank.

Warren said deregulation supported by Powell over the past four years has undermined the financial stability of the banking system. I believe that is an accurate description. Powell’s actions have moved the US closer to future financial crises and bailouts funded by taxpayers, as happened in 2008.

The actions were aimed at the most important reforms after 2008 across five key areas: capital requirements, supervision, proprietary trading, living wills to allow stricken banks to be safely unwound and the amount of assets banks must hold that are “liquid” and easy to sell.

Each of those financial protection rules were significantly weakened by the Fed under Powell, leaving the overall structure of the regulatory framework impaired and materially reducing the resilience of banks. The deregulation also made it harder for regulators and the public to know the actual condition of the banks, making crisis planning and mitigation more difficult.

Diluting the regulatory stress tests that lenders must go through weakened the capital requirements that enable banks to absorb their own losses without failing and needing taxpayer bailouts. These include scrapping the assumption that the banks would continue to lend during stressful periods and expand their balance sheets. Under the old test, banks in such a plight would have been required to increase their capital.

The test also previously assumed banks would continue to pay dividends over the following two years, thereby depleting their capital. Removing that assumption eliminates the requirement for the banks to have sufficient capital to cover those payouts.

In a dissenting opinion issued on the stress tests changes, Fed governor Lael Brainard said the rule changes gave a green light for large banks to reduce their capital buffers materially. She argued that the rule change would result in a $60bn, or 5 per cent, reduction in the current capital requirements for the highest quality capital across the largest banks and that the actual amount of capital held (which includes management applied buffers) could reduce by twice as much.

The effect on banks with assets in the $250bn and $700bn range would be even greater because the additional capital charge for being the largest, systemically important banks does not apply to them, despite some still being large enough to cause systemic issues and contagion. We now have much less confidence that any large bank can withstand a crisis.

Requirements for banks to hold adequate amounts of liquid, high-quality assets to fund outflows were lowered, particularly for those in the $250bn to $700bn asset range. This action has needlessly jeopardised big bank liquidity positions, leaving them more vulnerable to insolvency under stress.

Under Powell, the Fed eliminated its own ability to restrict bank dividends and share buybacks in response to especially poor supervisory assessments. When used, this restriction enabled the Fed to get the attention of shareholders and provide motivation for banks to fix their own problems. On top of that, the Fed made it easier for banks to deplete their capital via share buybacks and dividends, even in times of extreme stress.

In addition, full and complete living wills now must only be submitted to the Fed every four to six years instead of effectively every two years. Considering how much a bank can change in that time, the living wills might be irrelevant, undermining the very purpose of the exercise. For example, a 2004 living will for Lehman Brothers would be likely to have been largely useless when it crashed in 2008.

Finally, the restrictions put in place by the Volcker rule’s ban on proprietary trading were eroded by a set of exclusions and definition changes. Allowing banks to trade on their own accounts encourages risk-taking and even gambling-like behaviour.

Not only did Powell’s Fed allow banks to engage directly in more of these types of activities, but they were also enabled to do more of it indirectly through investments in venture capital and loan funds, some of which have been shown to be unstable and unsafe.

The dissents from Brainard and FDIC Director Martin Gruenberg also point to the many dangers of the Fed’s actions under Powell. These deregulations have weakened the financial reform legislation meant to protect Main Street families’ jobs, homes, savings and so much more.


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