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March 5, 2018

New Fed Chairman Powell grilled at Senate Banking Committee

Questions address effects of bipartisan Crapo Dodd-Frank relief bill; Wells Fargo consent order; capital rules; HMDA

The Senate Banking Committee on March 1, 2018, held a hearing to receive the Federal Reserve's semiannual report on monetary policy. The only witness was newly confirmed Fed Chairman Jerome "Jay" Powell, who testified at the House Financial Services Committee earlier this week. Powell's remarks about monetary policy, inflation, growth and unemployment were well covered by media outlets, but he also addressed a number of financial regulatory issues. Testimony from the hearing and the Fed's monetary policy report are available here.

Chairman Mike Crapo (R-ID) said the semiannual hearing "has often served as an opportunity for members of this committee to review the new regulations imposed in the wake of the financial crisis." He said discussions with previous Fed chairs such as Ben Bernanke and Janet Yellen had helped in preparing Crapo's bipartisan bill easing regulations for "community banks, credit unions, midsize banks and regional banks" (S. 2155), which the committee approved on December 18 and the full Senate will begin debating next week. Crapo pushed back on the idea that the economy's improving picture makes the bill less necessary or more risky. "A number of commentators have expressed sudden concerns about the economy overheating," he said. "While the Federal Reserve should remain vigilant in monitoring inflation risks, we must also continue to pursue common-sense pro-growth policies that will lead to increased innovation, productivity and wages."

Ranking Member Sherrod Brown (D-OH) said 2017 was the worst year for job creation since 2010; that wage growth has been slow; labor force participation "has barely improved since 2014," and "nine years of job growth has still not done much to narrow income inequality, or address employment disparities … Instead of addressing these problems and their problems, Republicans are working hard to make sure that Wall Street banks rake in even bigger profits." Brown said Wells Fargo in January had announced a $22 billion stock buyback, or "288 times what it will spend on pay raises for workers … It's pretty simple: for each pay raise or bonus for workers, companies are spending 100, 150, 200 times as much on stock buybacks and executive compensation, and it gets worse." Brown noted that Citigroup had announced that "it illegally overcharged 2 million credit card accounts for over five years" and will refund $335 million to consumers. Turning to S. 21255, the bipartisan Crapo bill, Brown said, "Many of us in this body are concerned about this deregulation bill … especially when it comes to foreign banks … that are huge, but their assets in this country are under $250 billion. They're both troubled and troubling banks in their international operations, yet [Treasury] Secretary Mnuchin sat at that table and said he plans to deregulate some of these banks, like Deutsche Bank and Santander. And we know the fines they've paid and the problems that they have caused internationally."


Effects of regulatory relief bill. In his questions, Chairman Crapo got Powell to agree to several points about S. 2155: 1) that under the bill the Fed would still be required to conduct a capital stress test for any bank with total assets between $100 billion and $250 billion; 2) that the Fed would retain authority to apply any prudential standard to a bank with between $100 billion and $250 billion in total assets if that was found to be appropriate; 3) that the expanded asset threshold does not weaken oversight of the largest globally systemic banks; 4) that the bill would not exempt international banks like Deutsche Bank and Santander from Dodd-Frank Section 165, because the Fed considers their "global total consolidated assets"; and 5) nothing in the bill "would restrict the Fed's ability to ensure that large financial institutions are well-capitalized."

Volcker Rule. Asked if Powell supported exempting community banks with less than $10 billion in total assets from Dodd-Frank's Volcker rule, which bans banks from proprietary trading for their own accounts and owning private funds, Powell said, "I think that is a sensible thing to do, yes." When asked about concerns that the bill would allow a community bank to purchase a hedge fund, Powell said, "We would still apply all of our safety and soundness supervisory activities to that bank, and we would be looking for things like that and find them." Crapo ended his questions with a plea for the Senate to confirm Randal Quarles, the Fed's vice chair for supervision, for a full term as a Fed governor. Quarles is serving a four-year term as vice chair but his "underlying" 14-year term on the board of governors has expired.

Ranking Member Brown said that despite Powell's apparent "general satisfaction" with S. 2155, "There have been serious, serious, serious questions raised about" the bill by former Fed chair Paul Volcker, former deputy Treasury secretary Sarah Bloom Raskin, former FDIC chair Sheila Bair, former Treasury counsel Antonio Weiss and Paul Tucker, former deputy governor of the Bank of England. "It's not all candy and roses here," Brown said.

Bank consolidation. Brown said Morgan Stanley and other market analysts have estimated that only 13% of the reduced taxes paid by companies under the Tax Cuts and Jobs Act will go to workers' pay, with 18% going toward to mergers. "If that ratio holds up for banks … shouldn't we expect even more bank consolidation?" Powell said, "We don't really know yet how that will shake out … bank consolidation has been going on for 30-plus years. It's got a lot to do with smaller banks and economic activity moving out of the rural areas into the city, and interstate banking and things like that. I am not sure this would tend to change the trend."

Tailoring bank rules.Brown said S. 2155 would mandate that the Fed further "tailor" rules for the largest banks, while "Vice Chair Quarles is talking about the Fed's plans to make living wills less frequent, to reduce leverage rules, to weaken the Volcker rule. Why should big banks that have consistently failed to follow the rules benefit from statutory or regulatory rollbacks?" Powell said, "Our focus is very much on the smaller and medium-sized banks. We want the post-crisis regulatory initiatives like higher capital, higher liquidity, stress testing, resolution … to apply in their strongest form to the largest institutions. We want to make sure we're doing that efficiently, and there are some changes we can make in that regard … As I see the parts of the bill that I am familiar with, they really apply to banks $250 billion and under … When you say 'largest banks,' I think you are talking about either the eight SIFIs, one of which is below $250 billion in assets. So we're very capable of reaching below $250 billion to apply enhanced financial standards when appropriate."

Debate over large foreign banks. In his questions, Jon Tester (D-MT), one of the Democrats supporting the chairman's regulatory relief bill (S. 2155), said he "fundamentally disagreed" with the "perception being floated by some that the largest foreign banking organizations [FBOs], such as Barclays, UBS, Deutsche Bank … will be released from enhanced prudential standards under" under the bill. Tester got Powell to agree that the bill doesn't require the Fed to "weaken" any Dodd-Frank enhanced rules for FBOs like those three banks. Powell said the bill "moves up to $250 billion for these institutions, but it looks at their global consolidated capital … Now, if we have intermediate holding company requirements for these companies, none of those would be affected by this. That means … they're required to keep capital and liquidity here in the United States that's commensurate with their activities. They're also subject to living wills and things like that. So it's a range of enhanced prudential standards." Tester further got Powell to clarify that international holding company (IHC) requirements imposed by the Fed were not a part of the Dodd-Frank regime, and that S. 2155 doesn't require any change to those rules.

Cost-benefit analysis. In his questions, Richard Shelby (R-AL) noted that the Fed had recently announced plans to create "what they call a 'policy effectiveness and assessment unit' to conduct cost-benefit analysis on regulations." He asked about the unit's status and "what you hope will come out of this." Powell told him, "We're trying to raise our game here by having a specific group of … quantitatively oriented people who are focusing just on that. We have lately published cost-benefit analysis on specific regulations like the SIFI surcharge, long-term debt and things like that." Later in the hearing, Catherine Cortez-Masto (D-NV) asked for more detail on the new cost-benefit unit. Powell told her the office has "five or six people now. I don't know how big it'll be, but it's going to be something in that range, maybe a little bigger … The idea is that we'll have a strong quantitative approach that's tightly focused on cost-benefit analysis."

'Risk blind' capital rule. In his questions, David Perdue (R-GA) asked about a part of the Fed's leverage ratio that requires banks to hold capital against all assets regardless of their risk, called a "risk blind" model. "I have a hard time understanding why assets like Treasury securities and funds on deposit at the Federal Reserve are also in that calculation. Can you defend that?" Powell told him, "My view is that the binding capital requirement should be the risk-based capital requirement. And that would take into account Treasuries and reserves and how risky they are. The issue is that over time, banks have figured out ways to game risk-based capital. So we want a hard backstop, and that hard backstop should be high and hard. It should be the leverage ratio … We don't want the leverage ratio to be the binding constraint most of the time, because that, frankly, encourages people to take more risk … risk-based capital has been vastly improved since the crisis. So that's how we think about it."

Crapo bill's effect on HMDA. In her questions, Sen. Cortez-Masto (D-NV) noted that S. 2155, the Crapo reg relief bill, "would exempt 85% of depository institutions from full reporting of loan data under the Home Mortgage Disclosure Act" [HMDA]. She asked how the loss of this data might impact the Fed's ability to conduct its obligations under the Community Reinvestment Act, such as supervisory exams. Powell said the Consumer Financial Protection Bureau (CFPB) writes the HMDA regulations. "And we use that data in what we do, in supervising the banks we supervise, which is a smaller group … Dodd-Frank took the base of historical data collection and significantly increased that. So my understanding is that what's being looked at in the bill is to create a broader exemption just from the Dodd-Frank additions. I think we traditionally get almost everything we need from the historical data."

But Cortez-Masto said she was concerned that the data used in CRA supervisory exams "seems to exclude relevant data points," with little detail about loans of less than $1 million, and "no analysis whatsoever of whether lending is occurring in communities of color, despite easy and accessible data via the [HMDA]." She asked if the Fed has considered broadening those criteria for CRA exams, and which factors would be helpful in determining whether "small businesses, communities of color and low-income areas are truly receiving the support the law intended." Powell told her that HMDA data "is really an issue for the CFPB … and we generally defer to them in terms of what their view is on that … My understanding is that we'll still have, under this bill, the information that we've traditionally relied upon for just about everything we do under HMDA. We may not have the additional data from some institutions, but we think we'll be able to function."

Wells Fargo consent order. In her questions, Elizabeth Warren (D-MA) noted that on former Chair Yellen's last day in office, the Fed issued a consent order against Wells Fargo, prohibiting it from growing any larger until it made certain improvements, and "effectively forced Wells to remove an additional four board members this year." She asked if the Fed will have to vote on whether to accept two reports that Wells Fargo must submit in April — one on improving the effectiveness of the board, and another on improving the board's risk management practices. Powell said he believed the Fed has delegated that approval to its head of supervision, Randal Quarles, but "I assure you, that will take place in serious consultation with the board." Warren said that in her view, a process largely involving staff "is not good enough … Fed board members are supposed to make the big decisions, and Fed board members are supposed to be accountable for these decisions." She asked if Powell would consider requiring the Fed to vote on the plans first; Powell said he would.

Warren then noted that an independent third party must review Wells' implementation of the plans by the end of September. She asked if Powell would commit to making that independent review public, with redactions as necessary. Powell said he could not commit to that without discussing it first with other governors and staff, but he would look into it, "if there's a way to do it that's faithful to our obligations and our practices." Warren said the growth restriction imposed on Well Fargo can be lifted if the bank "adopts and implements" the two plans. "I hope that you won't consider lifting it just because Wells makes some marginal progress," she said. "Wells should fix its problems before it is permitted to grow any bigger."

Student debt. In his questions, Brian Schatz (D-HI) said there is currently $1.4 trillion in outstanding student loan debt, making it the highest category of consumer debt behind mortgages, and also "the most delinquent," with 11% of borrowers seriously delinquent or in default. In contrast, at the height of the financial crisis mortgage delinquency was just under 5% and is now around 1%." Schatz asked if that level creates "a drag on the economy." Powell said, "I think it's important that people be able to borrow to make what may be the most important investment of their lives, which is in their education. So overall … borrowing to invest in yourself is something we should foster, subject to a couple of important caveats," such as ensuring that borrowers understand "the risk that they're taking and the possible payoffs." He added that student debt is not allowed to be discharged in bankruptcy, and "I'd be at a loss to explain why that should be the case … You do start to see longer-term negative effects on people who can't pay off their student loans, and it hurts their credit rating, and it impacts the entire path of their economic life."


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Monetary Policy Report