Criticism of the Fed is coming from a relatively new direction just now, Bloomberg is reporting this week.
The administration has been a persistent critic for not reducing interest rates further and quicker — but now the bank is being accused for “running the risk of fomenting an eventual financial crisis by easing banking regulations at the same time that it’s cut interest rates.” The criticism is coming from “some former Fed officials, including ex-Vice Chairman Alan Blinder and financial stability experts Daniel Tarullo and Nellie Liang, Bloomberg says.
They worry that the combination of looser credit and laxer rules will prompt financial institutions and investors to pile on leverage and take excessive risks.
After lowering rates three times, Fed policy makers left them unchanged on Dec. 11 and forecast they would stay that way through the 2020 presidential election year. The central bank has also made or proposed various changes in financial oversight, including alterations to the stress tests that banks undergo and an overhaul of the Volcker Rule’s trading restrictions.
Some observers including presidential candidate Elizabeth Warren have warned the central bank against loosening its regulatory grip.
Liang, who was nominated by President Trump to the Fed board but later withdrew, voiced concern about mushrooming corporate credit. “I worry that defaults and investor losses will be higher than expected in the next downturn and will make the next recession more severe,” she said.
Fed leadership has pushed back hard against any suggestion it has made the financial system more vulnerable by loosening regulations, arguing that the capital requirements of the biggest banks “remain as tough as ever.” The U.S. has “a stable, healthy and resilient banking sector,” Randal Quarles, Fed vice chairman for supervision, told lawmakers on Dec. 4.
He said that the Fed’s focus has been on tailoring the regulation of regional and smaller lenders. “One of our principles has been to ensure that we do not reduce in any material way the loss absorbing cushion of the institutions,” he said “I think we have succeeded in doing that.”
Former Fed Governor Tarullo is not so sure. He zeroed in on the stress tests, including the disclosure of more information about the models behind them. “I suspect quite strongly that the effective amount of capital the banks have to have for a given portfolio is lower because they have so much more information about the stress tests,” said Tarullo, who was the Fed’s point man on regulation after the 2008 crisis and is now at the Harvard Law School.
Ex-central bank Vice Chairman Donald Kohn welcomed efforts to tailor rules to fit the size of the institution but cautioned regulators against taking their eye off of “very sizable” regional banks. “You get a bunch of regional banks all doing the same thing at the same time then that could be systemic,” said Kohn, a member of the Bank of England’s Financial Policy Committee.
There’s also “reason to be cautious about what’s going on outside the banking system when you lower rates because you have fewer macro-prudential tools to deal with that sector,” he said.
For example, under the Dodd-Frank Act, the sweeping post-crisis regulatory reforms introduced to strengthen the banks, the Financial Stability Oversight Council monitors the overall financial system. Headed by Treasury Secretary Steven Mnuchin, it has the power to designate nonbank financial institutions such as insurance companies as systemically important and so subject them to increased regulation.
The council, which includes the heads of the Fed, the Securities and Exchange Commission and other regulatory agencies, has recently shifted its focus toward monitoring potentially risky financial activities and raised its hurdle for singling out individual firms for more supervision.
“They come very close to saying that they’re never going to designate a nonbank no matter what,” Tarullo said.
Former Fed Vice Chair Alan Blinder said Trump appointees at other regulatory agencies were more to blame for what he called “backsliding,” but thought the Fed is “not immune and shouldn’t be easing credit and bank rules simultaneously.”
“You can try to push up aggregate demand and expand the economy but don’t drop your regulatory safeguards as well,” the Princeton University professor said.
Some current Fed policy makers share the concerns of their former colleagues. For example, Fed Governor Lael Brainard has voted against some of the board’s rule changes while Boston Fed President Eric Rosenberg has called for higher bank capital in today’s low interest rate environment.
Liang, who is friend of Powell’s, said she agrees with him that financial stability risks aren’t elevated currently. “If you took a snapshot of the situation now, it looks OK,” the Brookings Institution fellow said. “But I worry about what the situation would look like in a year or two given the incentives from recent policy changes.”
So, we will see. These are important concerns, but likely will be unpopular just now given the improved prospects for the economy since the phase one China deal seems to be agreed. Still, they are extremely important and should be watched closely by producers amid the current political horse trading, Washington Insider believes.
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