Yellen says 'I absolutely intend to serve out my term'; says supplemental leverage ratio for large banks may need to be 'recalibrated'; members ask her to hold off on rulemaking until Quarles is confirmed as Vice Chair

The House Financial Services Committee on July 12, 2017, held a hearing to receive the Federal Reserve's semiannual report on monetary policy from Chairman Janet Yellen, who was the only witness. Yellen's remarks on topics such as interest rates; U.S. economic growth and global economic trends; unemployment; inflation and the Fed's balance sheet were widely covered in the media, so this alert focuses more on her comments on the Dodd-Frank Act and other financial regulatory matters. Testimony from the hearing, and the Fed's monetary policy report, are posted here.

In his opening statement, Chairman Jeb Hensarling (R-TX) said the Fed should "set out an easily discernible and transparent policy strategy to achieve its mandate and, but for highly exigent circumstances, to stick to it. Forays by the Fed into fiscal policy, specifically credit allocation, cannot and should not be permitted." He said the Fed's "intervention into distinct credit markets like mortgage-backed securities is inherently fiscal policy, not monetary policy. Already, there is talk of having the Fed bail out student loans and public pension funds … if we are not careful, we may wake up one day to find our central bankers have instead become our central planners." Hensarling said that paying interest on excess reserves held by the Fed "should not become a permanent tool of monetary policy … . So let's hope the normalization has truly begun."

In her statement, Ranking Member Maxine Waters (D-CA) said that "since day one, the story of the Trump Administration has been one of chaos and turmoil. This creates uncertainty that threatens the progress of our economy and the opportunities available to all American households." She noted that the president had "reversed a planned cut to Federal Housing Administration mortgage insurance premiums that would have saved homeowners $500 a year. He issued executive actions to begin to dismantle Wall Street reform and embraced the 'Wrong CHOICE Act,' " which Waters said would "hobble" the Fed and "gut" Dodd-Frank. She said Republicans are trying to "weaken the independence of the Fed and chain the Fed's policy decisions to a mathematical formula" through the House-passed CHOICE Act. Waters said the administration's nomination this week of Randal Quarles for the position of Fed vice chair of supervision, "an important post responsible for overseeing the Fed's implementation of Wall Street reform … is troubling, given Quarles's public opposition to key aspects of the Dodd-Frank law and support for measures that would curtail the Fed's independence."

Federal Reserve Chairman Janet Yellen's prepared testimony dealt exclusively with monetary policy and other economic issues.

Questions

Chairman Hensarling asked Yellen if she agreed with a distinction between monetary policy and credit policy as defined by professor Marvin Goodfriend of Carnegie Mellon University, who said credit policy "involves lending to private institutions or acquiring non-treasury securities with freshly created bank reserves." Hensarling also asked if she thought credit policy was commensurate with the Fed's congressional mandate. Yellen said the Fed "has clearly indicated that it intends to return, over time, to a primarily Treasury-only portfolio … in order not to influence the allocation of credit in the economy," and that the Fed's purchases of mortgage-backed securities were prompted by the financial crisis. Hensarling then asked if the Fed can legally purchase student debt guaranteed by the federal government and municipal debt that matures in less than six months. Yellen said she was not sure if the Fed was able to purchase student debt, and the Fed board not discussed whether to do so or to purchase municipal debt. Hensarling closed by saying he was "very heartened to see in your report a comparison of Fed policy with a number of policy rules," and encouraged Yellen to "go further and discuss not how, but why that the actual [Fed] policy differed from these policy rules."

Ranking Member Waters commended the Fed for recently fining Deutsche Bank, "a top creditor of the President and his immediate family, for its failure to comply with anti-money-laundering requirements … . Were you able to verify that Deutsche Bank had completed its own internal review of a Russian mirror trading scheme that took place from 2011 to 2015?" Waters also asked if Yellen could comment on "the due diligence that the bank conducted on the accounts of President Trump and his immediate family members." Yellen told her the Fed had "issued an enforcement action against Deutsche Bank for violations of Bank Secrecy Act anti-money-laundering procedures in the United States, and that was based on our own investigations. The mirror trades that you referred to occurred outside the United States. Recently, the U.K. [Financial Conduct Authority] took an action against Deutsche Bank for those trades. Those are not ones that we're involved in looking at, and we haven't, of course, in the course of our investigations, looked into individual transactions with the president … Our focus has been on the safety and soundness of the operations of Deutsche in the U.S."

Andy Barr (R-KY) Asked about the Fed's practice of paying a 1.23% return on reserve balances, which he said gives banks "a government subsidy to not lend out their reserves." But Yellen said the data did not show that the Fed's IOER policy is deterring banks from making loans. Barr then turned to the Medicaid reforms proposed by the House and Senate health care bills repealing the Affordable Care Act, asking if she agreed that "the structure of our welfare programs, including Obamacare, contain disincentives for work." But Yellen told him that "the major factor in the slow [economic] growth that we have … reflects, in part, an aging population that is putting downward pressure on labor force participation."

Gwen Moore (D-WI) asked about the Fed's application of "rules-based" monetary policy, such as the so-called Taylor rule. Yellen said she doesn't believe that the Fed should "mechanically follow any single, simple rule … As we try to point out in the report, there are many different rules. There is no clear way to decide which one is better than others. They lead to a range of recommendations." Moore then asked what Yellen thought of the House-passed CHOICE Act's (HR 10) provisions requiring the Fed to follow a rules-based approach, and its language requiring the Fed to be funded through the congressional appropriations process. Yellen said, "I'm opposed to the requirements in the CHOICE Act … I would be very concerned about subjecting the Fed to appropriations … We seek to be transparent, to be accountable to Congress and to communicate as clearly as we can the basis for our actions in monetary policy and also in supervision." She added that the Fed's funding outside of appropriations is an important part of its independence.

Carolyn Maloney (D-NY) asked if Yellen is "open to serving another four years as Fed chair if President Trump decides that he wants to renominate you." Yellen told her, "I absolutely intend to serve out my term. I'm very focused on trying to achieve our congressionally mandated objectives, and I really haven't had to give further thought at this point to this question." Maloney then noted that the Fed has suggested that the stock market is "currently overvalued. Are there other markets that you consider or see as overvalued, as well? And do you think a correction in any of these markets would cause problems for financial stability?" Yellen said, "As asset prices have moved up, we have not seen a substantial increase in borrowing based on those asset price movements. We have a financial system, a banking system that's well-capitalized and strong, and I believe it's resilient."

Blaine Luetkemeyer (R-MO) said he appreciated recent comments by Fed governor Jerome Powell on issues like the treatment of margin under the supplemental leverage ratio and on "CCAR," an element of stress tests that applies to the largest banks. Luetkemeyer said that in her response to a letter he had sent on CCAR stress testing, Yellen had "indicated that, while you understood my concerns, the Fed wasn't necessarily looking to curtail some of its stress-test-related activity. So now that a vice chair for supervision has been named, I'll again ask that the Fed hold off on imposing any new supervisory burdens before that individual is in place." Yellen told him, "We have a relatively light regulatory agenda at this point. I'm pleased to see a nomination. Clearly, we will look very carefully at the whole set of issues around regulatory burden, and look forward to having the input of that individual, if he's confirmed."

When Luetkemeyer asked her about the Treasury's recent report outlining proposals for regulatory relief, including a number of recommendations for changes to the Fed's capital and liquidity rules, Yellen said, "There are many very useful and productive suggestions that mirror things that we have been thinking and doing ourselves, with respect to tailoring of our regulations, reducing burdens on community banks. I think the recommendations pertaining to the Volcker Rule, and looking for ways to reduce burdens, are all very useful. There are a few points where we have a different view, but there's a lot in it that is very useful."

Later, in questions from Bill Foster (D-IL) about the Fed's supplemental leverage ratio for larger banks, Yellen said, "A leverage ratio was meant to be a backup supervisory device calibrated appropriately relative to risk-based capital requirements. While in general I think risk-based capital requirements, especially for the largest and most systemic institutions, are at levels that I think are appropriate and am comfortable with, it may be that the supplementary leverage ratio needs to be recalibrated relative to that. I am very much aware of the problems you're mentioning and considering how to address them."

Bill Huizenga (R-MI) asked about "concerns regarding a lack of liquidity in certain fixed-income markets.' He noted that when previously questioned about this, Yellen had said "we don't see a problem," but needed to study it further. "Has there been additional study and follow-up by the Fed on that particular issue?" Yellen said, "There's been a number of studies inside the Fed, and also outside of it, that show … no clear pattern, some suggestions that regulations may be negatively impacting liquidity, but other studies reaching different conclusions … The inventories of bonds held by some of the largest banks and market makers have declined. On the other hand, bid-ask spreads are low, corporate bond issuance has been healthy, the market's done well." Huizenga said the Capital Markets Subcommittee he chairs will examine this issue at a hearing this Friday.

Huizenga noted that in one of his final speeches before leaving the Fed, former Fed Governor Tarullo had suggested that a "new regulatory paradigm is needed to expand fiduciary duties of directors of banking institutions," and had asked whether "existing modes of financial regulation could be further supplemented by modifying the fiduciary duties of the boards of regulated financial firms to reflect … regulatory objectives." Huizenga said Tarullo had argued that "traditional fiduciary duties focused on shareholders are inadequate for banking institutions." He asked if Yellen agreed with Tarullo's remarks. Yellen told him, "I'm not prepared to say that I agree with all of those recommendations. We're focused on trying to clarify expectations for boards of directors, to distinguish the important role that they have in a banking organization, and what is the job of senior management versus a board of directors."

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