Nominees are questioned about CCAR stress tests, Volcker Rule, Treasury's regulatory relief report; Otting is queried on foreclosures and robo-signing at OneWest

The Senate Banking Committee on July 27, 2017, held a hearing on the nomination of Randal Quarles and Joseph Otting to be Federal Reserve Vice Chair of Supervision and Comptroller of the Currency, respectively. Testimony from the hearing is posted here. Before the hearing, the committee went into executive session to approve several nominees to the Treasury Department, the Commerce Department and HUD, including Christopher Campbell to be assistant Treasury secretary for financial institutions. All were reported to the floor by voice vote except for J. Paul Compton Jr.'s nomination to be HUD's general counsel. Democrats asked for roll-call vote on his nomination, and Compton was approved by a vote 15-7.

Chairman Mike Crapo (R-ID) did not make an opening statement. In his statement, Ranking Member Sherrod Brown (D-OH) said Quarles' statements as a senior Treasury official, in the period leading up to the 2008 financial crisis, "lead me to winder if he was asleep at the switch or willfully turning a blind eye to Wall Street's abuses and excesses." Brown said that "contrary to Mr. Quarles' predictions, in 2006 the economy was not 'strong,' the financial sector was not … 'healthy,' and our future was not … 'bright.' The banks were not, as he said at the time, 'well capitalized,' and as a result taxpayers paid billions to bail these banks out, while Mr. Quarles and his company turned a profit off of the crisis. Exotic mortgage products were not confined to … 'upper-income individuals that can manage a sizable increase in their monthly mortgage payment.' " Brown said that for "wealthy bank executives, for private equity investors, the crisis … was an opportunity to profit by flipping failing banks bought at rock-bottom prices and foreclosing on working families, all while raking in taxpayer dollars."

In his prepared statement, Randal Quarles said that "regulatory policies enacted since the financial crisis have improved the safety and soundness of the financial system. But as with any complex undertaking, after the first wave of reform, and with the benefit of experience and reflection, some refinements will undoubtedly be in order." Quarles said that former Fed Governor Daniel Tarullo had said as much in an April speech as he departed the Fed. "The key question will be ensuring that, as we continue to refine the system over time, we do so while maintaining the robust resilience of the system to shocks." Quarles said he has been a practicing lawyer versed in the "granular technicalities of the most complex aspects of the financial system" as well as an investor in community banks. "I have been a financial regulatory policy maker under two different presidents in two different decades," including in 1992 during the "cleanup phase" of the savings & loan crisis.

Joseph Otting said his experience had allowed him to "work for one of the largest banks in the nation, two well-respected regional banks and a community bank. I have touched virtually every segment of the industry — including serving consumers, businesses, trust functions, private banking, investment services, legal, human resources, compliance, audit, treasury, financial management, operations and technology." Otting said that he decided to take the position with OneWest "because I felt that Southern California was in need of a 'hometown bank.' " He said that OneWest "was able to grow beyond primarily mortgage originations to a bank with a full suite of products and services for local businesses, families and consumers.

Questions

Chairman Crapo noted that former Fed Governor Tarullo had given a speech in April where he highlighted six areas where regulatory relief would be appropriate: 1) changing Dodd-Frank's $50 billion asset threshold for "SIFI" banks; 2) simplifying the Volcker Rule; 3) providing a simpler capital regime for community banks; 4) revisiting the supplementary leverage ratio; 5) raising the $10 billion asset threshold for company-run stress tests; and 6) potentially eliminating the qualitative portion of the CCAR stress test for all banks. He asked if Quarles agreed with those recommendations; Quarles said they were "very much in line with how I would approach regulation." When Crapo asked what other areas of regulatory relief would be appropriate for the committee to consider, Quarles said he would want transparency to be a theme, "both as an appropriate relationship between the regulator and regulated, and as a matter of improving the content of regulation." He cited the example of the lack of transparency surrounding the CCAR stress tests.

Chairman Crapo then gave Otting the opportunity to respond to questions raised about foreclosures and "robo-signings" after IndyMac was taken over by the FDIC, sold to Steven Mnuchin's investment group and renamed OneWest. (Mnuchin is now the Treasury secretary.) Reading from a prepared text, Otting said that managing the bank during that time was "like going into a fire," and that while it was a tragedy that some homes were lost, 80% of the bank's 150,000 problem mortgages "were able to be saved" through modifications and principal forgiveness. He said issues with robo-signing were limited to loans for which OneWest was only a servicer.

Ranking Member Brown also asked Otting about foreclosures and robo-signing, saying, "You permitted your bank to break the rules while making life harder for homeowners trying to stay in their homes." Otting said that out of 29,000 loan modifications, OneWest had made only "29 mistakes … our error rate was incredibly low." Turning to Quarles, Brown said he had "downplayed risks in the financial sector" before the crisis, and asked if Quarles had done "everything you could have." Quarles told him, "We believed that given the information we had from the regulatory system, that the risks building up were manageable … We did believe there were measures to be taken that could improve the resiliency of the financial system … We began a process for presenting a program for change … In hindsight, we could have been more aggressive in pushing that program forward. In advance of the crisis, the political obstacles to the changes that we thought would have been appropriate to improve regulation would have been formidable. So we proceeded cautiously — maybe too cautiously."

Brown then asked if Otting agreed with Treasury's recent report listing proposals for regulatory relief, saying "most of that report focused on easing rules for the largest banks, including decreasing capital requirements." Otting said the report had a lot of recommendations, and that he supported the recommendations relating to community banks. Brown finished his questions by saying, "The president says we must drain the swamp, but surrounds himself with what looks like a Wall Street executive retreat in his Cabinet. I hope you are not part of any effort to weaken capital requirements."

Pat Toomey (R-PA) noted that he has never supported Dodd-Frank's orderly liquidation authority (OLA) for resolving a large, failing bank, and wants to change the bankruptcy code instead. Quarles told him that "the discretion of regulators should be as constrained as possible, and where discretion remains, those regulators should be as clear as possible about how they will exercise it in the future, so that their actions are predictable and there's less uncertainty as to what the … policy will be … . The right way to approach continuing to improve the environment for the resolution of financial institutions is to improve the operation of the bankruptcy code … " Toomey then said that the models and testing procedures for the CCAR stress tests are not transparent and the Fed has not done enough to determine if CCAR is "inadvertently procyclical … I urge you to consider the extent to which CCAR is even necessary any more, especially given the DFAST mechanism," referring to the acronym for the Dodd-Frank Act Stress Test. Later, Toomey got Otting to agree that there should be no further FSOC SIFI designations of non-banks until the designation process has been modified.

Elizabeth Warren (D-MA) described Quarles' career as "spinning through the revolving door" between government and the private sector, with "more than a decade in private equity and investment management, where you've argued repeatedly for weaker rules for the biggest banks … that's not a track record that should give Americans a whole lot of confidence in you." She asked if Quarles supported the proposals for regulatory relief outlined in a 124-page document released by the Financial Services Roundtable, such as changes to stress tests, capital and leverage requirements, and the Volcker Rule. Quarles said he had not read the FSR report, and he didn't have a view on the capital question, other than that "more could be done to ensure that in setting the capital rules for the full range of institutions in the system, that we can be more sensitive to the character of each institution." On Volcker, Quarles said he agreed with Tarullo's assessment that "the complexity of the rule makes it difficult to apply, and we should work to simplify it." He disputed Warren's description of the Glass-Steagall Act, an answer that appeared to frustrate Warren, who said, "I'm just looking for any area where you disagree with the large financial institutions, and I'm not hearing it."

Tim Scott (R-SC) asked the nominees if they agreed that the FSOC lacks an understanding of how insurance companies and banks have different business models. Quarles told him that the main risk with banks is the fact they are interconnected with other institutions and have liabilities that are vulnerable to runs. "Life insurance companies … could have a run if all the policyholders showed up and asked for the cash value of their polices at the same time … but that is a remote and historically unprecedented possibility. So they're quite different." Otting agreed with him. Later, Quarles agreed with Scott that tailoring of regulations is important, and "we should look very carefully at tailoring capital regulation and other types of regulation, including size."

Jon Tester (D-MT) also asked Otting at length about the robo-signing controversy at OneWest. Otting went through several kinds of problems associated with loan documents, beyond just robo-signing, and said the scale of mistakes at the bank was actually very low, as a proportion of its mortgages that were modified. Thom Tillis (R-NC) told the nominees that some of the larger banks will submit "80 to 1,000 pages annually to comply with CCAR stress test regulations," which he said was equivalent to 81 volumes of "War and Peace" or 20 to 30 feet of shelf space. Quarles told Tillis that better transparency was important for CCAR, because "it's not giving the entity the answer key, it's giving them the test … The benefits of transparency outweigh any of the theoretical costs."

Robert Menendez (D-NJ) said that after Quarles left the Bush administration in 2007 and joined the Carlyle Group, "you publicly advocated to change the rules limiting private equity in banks … in September 2008, the Federal Reserve announced a policy shift allowing for private equity firms to take larger ownership stakes in banks, and in 2009, the Carlyle Group and two other firms paid $12.8 billion for BankUnited … As part of that deal, the FDIC agreed to cover most of their losses, and in total made over $1.6 billion in payments, more than any other loss-sharing agreement during the financial crisis … Ultimately, BankUnited's failure cost the FDIC $5.7 billion, and the Carlyle Group and other investors walked away with more than $2 billion … So it seems you used your remaining influence in the administration to change the rules to make it easier for your new employer … to turn America's struggling banks into cash cows … [Quarles] lobbied the government so his employer could invest in deals where the FDIC took on all the risk and private equity investors would reap all the benefits, and the future of the community banks involved was only an afterthought." Quarles did not have an opportunity to answer.

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