The House Financial Services Committee yesterday (Wednesday, July 10) held a hearing on "The Federal Reserve's Semiannual Monetary Policy Report." The only witness was Federal Reserve Board Chairman Jerome Powell. Materials from the hearing are posted here.

Statements

In his opening statement, Chairman Patrick McHenry (R-NC) blamed the Biden administration for inflation. "Despite President Biden's gaslighting, inflation was not 9% when he took office. The out-of-control inflation we're experiencing now is something that this administration did not inherit, but it is a product of their policies and their overspending. The nearly $2 trillion partisan and fiscally reckless spending as a part of the American Rescue Plan poured fuel on a smoldering inflationary fire." He said the Fed "is trying to tame these flames, but it is the response to Democrat policies here on Capitol Hill and the administration." McHenry said that Powell "must not allow politics to cloud the Fed's monetary policy. However, despite your best efforts, the Fed's independence remains at risk. And unfortunately, calls are coming from inside the building. Under Vice Chair Barr, the Fed's regulatory and supervisory agenda has become politicized. Most notably, the development of the Basel III Endgame proposal has been a mess. This process has been cloaked in opaque standards and timelines set at meetings of unaccountable global governance bodies."

McHenry said that "recent press reports, which seem to be the only way Congress gets details on the Basel III Endgame progress, and your comments yesterday indicate the Fed will finally conduct a long-overdue Quantitative Impact Study. That is welcome. And if true, this is a promising development." McHenry said he is concerned about press reports that "the Fed will tuck any changes to the proposal into this Quantitative Impact Study. That study, including the substantial changes to the proposal, would then be issued for public feedback with a relatively paltry comment period. I will reiterate to you here what I've said to you in private: broad and material changes to the Basel III Endgame necessitate a full reproposal, full stop. Failure to do so will result in an immediate Congressional Review Act vote out of this House of Representatives as quickly as we can possibly process it." McHenry praised Powell's "steady and capable apolitical leadership," but urged him to "reject outside political pressure in this volatile time and stay the course for the good of the American people and our economy as a whole."

In her statement, Ranking Member Maxine Waters (D-CA) pointed to the strong U.S. economy, including a strong labor market. "Despite inheriting an economy from the prior administration that had the worst jobs record since the Great Depression, President Biden has now overseen a record 15.7 million jobs created since he took office, with 206,000 new jobs created just last month." Legislation signed by the president has "rebuilt our infrastructure, supported small businesses, eliminated mostly junk fees, wiped out more than $144 billion in federal student loan debt for 14 million borrowers, and cut child poverty in half." But she said recent data showed that "housing remains the number one driver of core inflation. Since 2020, house prices have increased by nearly 50% with Americans now spending on average over 30% of their income on housing. This is a top priority for Democrats but remains an afterthought for Republicans." Waters touted her comprehensive legislation housing package, including the Housing Crisis Response Act.

Turning to Project 2025, a proposed conservative agenda drafted by the Heritage Foundation, Waters said the project was "authored by almost two dozen former Trump White House staffers and Trump administration officials … Project 2025 promotes radical ideas to materially undermine the Federal Reserve if not effectively abolish it. MAGA wants to put you out of a job, Chairman Powell, so I look forward to your testimony and hearing from you, a Republican who was first nominated by President Trump, about your thoughts on the importance of the Federal Reserve and the work you have done to help our economy."

Federal Reserve Board Chairman Jerome Powell gave the same prepared statement he gave Tuesday (July 9) on the Senate side, with a review of the U.S. economic situation and the Fed's actions over the past year. Powell said, "Recent indicators suggest that the U.S. economy continues to expand at a solid pace … Strong job creation over the past couple of years has been accompanied by an increase in the supply of workers … Longer-term inflation expectations appear to remain well-anchored as reflected in a broad range of surveys of households, businesses, and forecasters … The most recent inflation readings … have shown some modest further progress, and more good data would strengthen our confidence that inflation is moving sustainably toward 2%."

Questions

Basel III Endgame bank capital rules

'Discussion' with FDIC, OCC. Chairman McHenry noted that on the Senate side Tuesday (July 9), Powell had said "potential changes have been made to the original Basel III Endgame [proposal], that a lot of progress has been made and that the board is very close to agreeing on the substance of those changes … If the Fed, the OCC and the FDIC agree on the substance of whatever changes you're going to make, what happens then? Walk through the mechanics as you anticipated." Powell told him, "We're very close to having exactly that agreement on the substance of the proposed changes, pursuant to those talks. The next question then is how to proceed. It is my view, and the strong view of a number of board members, that the appropriate thing to do is to take that new proposal and publish it, along with the effects of the Quantitative Impact Survey, and put that out for comment again and receive comment on that, and then take some time to review those comments before finalizing the regulation. And that's a discussion we're having with the other two agencies." But Powell added, "Now, we have not been able to reach agreement on a path to do that … . when we see broader material changes to an important regulation, we think, 'Let's go out again and give all the commenters another chance to comment.'"

McHenry said that if the Basel rules are opened up for a new comment period, "that means you have to get consensus for the [Fed] Board of Governors on the policy. You have to get the agreement of the scandal-plagued chair of the FDIC or the five-member board of the FDIC. You have to get agreement by the acting Comptroller of the Currency. These people should not have real standing … with the Fed on a matter of serious policy, especially with a chair of the FDIC that is being ousted by his own party as soon as they can get a replacement confirmed. It's an absurd thing that the Fed has to go to an acting Comptroller of the Currency and a guy who's going to be out of a job very soon at the FDIC and get agreement." McHenry asked if the QIS will "include the interplay with the stress tests, GSIB surcharge, all the other capital charges here?" Powell said, "It'll be this proposal, which does include changes to the GSIB surcharge, but does not include the stress tests."

'Strictly collaborative.' French Hill (R-AR) asked if it would be fair to say that "because of Dodd-Frank's role and the vice chair for supervision's role … [that] the Fed is a first among equals on proposing a rule like this? In other words, does the Fed have a supremacy position on determining whether [the rule] should be fully reproposed or not, or do you view it strictly as a collaborative basis?" Powell said, "I would say it's strictly collaborative, and I would say that our discussions with the FDIC, which Vice Chair Barr has actually been conducting, and the OCC, they've been very productive so far. So I want to make sure to say that. We've continued to work our way through this, and I believe we will get fairly soon to a resolution of the remaining process issue."

Only 'partial' reproposal. Later, in questions with Andrew Garbarino (R-NY) about whether the Fed is contemplating a "partial" reproposal of the Basel III rules, Powell said, "That's what we're looking at doing, is major things that we've been working on, and there will be additional changes that'll be made that won't be reproposed. That's what we're working on, rather than a full, wide proposal." Garbarino also asked Powell to elaborate on the resistance to reproposing from the FDIC and OCC. "So if the FDIC and the OCC are not yet on board with allowing for a new comment period, who is holding up this consensus? Is it Chair [Martin] Gruenberg, is it [CFPB] Director [Rohit] Chopra?" Powell told him, "I don't want to say that we're at odds. I just want to say we're working through this issue together … It's a discussion that we're having, and I think it's been constructive, and I think we'll try to keep it that way." When Garbarino asked if Powell could "at least answer whether or not the five-member FDIC board needs to sign off, or can you just go to the chair," Powell said, "The FDIC can speak for themselves, but I do think their board would be the question."

Timeline for reproposal. Frank Lucas (R-OK) also asked about what the "potential timeline around such a decision to repropose might look like." Powell said, "We've got pretty good agreement on the substance, and now it's about the process. A baseline might be that we agree on a reproposal of some kind that gives the public a chance to see these changes and react to them and write comment letters. So that could happen. It takes us a while to write it up. And then we put it out for 60 days. I think that couldn't happen probably until part of the way through the fall. Then there would be, let's say, 60 days of comment, and we get the comments. We'd have to then evaluate the comments and think carefully about them. Having done that, we'd have to write up the final version. And that would take some time … My guess is it puts you well into next year … . This is a very big piece of regulation, a lot of things that will need to be changed. There are a lot of good things in there. We want to come out with a good proposal, and that's what it'll take."

'Gold-plating' compliance. Ritchie Torres (D-NY) asked if Powell believes the U.S. banking system is sufficiently capitalized in the absence of Basel III. Powell told him he has long believed that "the level of capital in the U.S. banking system is about right." Torres asked why the Basel III changes are needed, if that is the case. Powell said, "There's no precise answer as to the appropriate level of capital … . we've been part of developing the Basel standards. It creates international, broad parity. It's important that we have that. It's important that we do something that's comparable to what the other large jurisdictions are doing and that it's consistent with Basel. And I think that's what our banks want." Torres asked if the U.S. should conform to the Basel III regime "without gold plating." Powell said, "Some things we've gold-plated and some things we haven't, but I think our Endgame proposal at the end should be consistent with the requirements of Basel and consistent with what the other large jurisdictions are doing."

Torres asked if Powell is confident that "there's no legal conflict between the standardization recommended by Basel III and the regulatory tailoring mandated by Congress." Powell told him that the Basel regime "doesn't impose any requirements on anyone. There's no enforceable requirements. Every jurisdiction does what it's going to do." Torres got Powell to agree that "if there were a conflict between the codified recommendations and an act of Congress," legislation would supersede the global Basel recommendations.

Fed's balance sheet. Chairman McHenry said that 2 ½ years ago, Powell had said, "The committee intends to slow and then stop the decline in the size of the balance sheet when reserve balances are somewhat above the level it judges to be consistent with ample reserves.'" He asked where the Fed is in terms of having "ample reserves." Powell said, "the runoff in the portfolio is now, I think, $1.7 trillion so far, so we've made quite a lot of progress. We think we have a good ways to go … We've now slowed the pace really with a view to getting as far as we can without creating frictions and disruption that might cause us to prematurely stop shrinking. Going a little bit slower might actually enable us to go further, and we think we have quite a ways to go. It's very hard to be precise about it. It's really a question of supply and demand, and we'll find that level with a little bit of a buffer on top of it, and that's where we'll stop."

SCOTUS Chevron ruling. Rep. Hill approvingly noted the Supreme Court's recent Chevron ruling and asked, "Would it be fair to ask you to certify that because of this change in Chevron, that the Fed would commit to promulgating new rules only if they're at the direction of an explicit congressional authorization?" Powell said, "We're studying that and several other decisions that have just come down in the last week or two. So I haven't got anything definitive for you on that … I know us to be an organization that is strongly committed to the rule of law. The Supreme Court says what the law is. We'll always do what we believe the law is."

Bank stress tests. David Scott (D-GA) said the Fed stress-tested 31 banks this year, up from 23 last year, noting that "all 31 banks remained above their minimum common equity Tier 1 capital requirements after observing losses of nearly $685 billion." Scott said Michael Barr, the Fed's vice chair of supervision, had said, "The goal of our stress test is to help ensure that we have enough capital to absorb losses in a highly stressful scenario, and this test shows that we do." Scott asked if the 2024 stress test results will have an impact on how regulators fashion a final Basel III capital rule. Powell said, "The two are really two different things. There is the Basel III capital proposal and then there's the stress tests. The stress tests are a different thing, and we realize we have to adapt those over time and be open to changes … but it's really a separate thing from the Basel III Endgame."

Later, Brian Fitzpatrick (R-PA) noted that the Fed's latest FR Y-14 information-gathering effort, which is used to help collect data for Fed stress tests, "asked banks for more detailed data on bank lending to nonbanks. As a result, there's concern that the Fed may start trying to indirectly regulate nonbanks and their financial risk. I just talked to one [nonbank] this morning that's concerned about that." Fitzpatrick asked if the Fed is planning to indirectly regulate nonbank financial institutions through stress tests. Powell told him, "That's not the idea. The idea is, we see intermediation growing very quickly in nonbanks. And we don't regulate them; we don't have a secret plan to regulate them or anything like that. The question is, what risks are being kept inside the banking system, which we do regulate and supervise? And what are the relationships between these large nonbanks and banks? We don't have a preconceived answer to that. We just want to understand, what are those business relationships like? And what kind of risks does that mean the banks are running? That's all it is."

Later, Young Kim (R-CA) asked if there are any conversations at the Fed about "having more transparency and better engagement and consistency with stress tests." Powell said, "We have increased transparency in the stress tests over time … if people want to write articles and make comments that are critical of the stress test, we're going to read those and we're going to think about that. We're open to improving and we know that the stress test has to evolve over time, if it's to remain relevant. And I think transparency is one of those subjects where we're prepared to listen and think about ideas." Kim said she would like to see a stress test regime "that is more transparent and adaptive, identifying unforeseen risks. So, we can achieve that by being more collaborative."

Bank liquidity rules. Rep. Garbarino said he wanted to "emphasize the need for the Fed to conduct a comprehensive, data-driven, and most importantly, transparent assessment of the current liquidity framework." He asked if Powell would commit to conducting "a public Quantitative Impact Study and a full notice and comment rulemaking before imposing any new liquidity requirements." Powell said that on liquidity rules, "I'm not exactly sure what we're contemplating there. We certainly contemplate getting a full range of input from the public on that, because some of these are novel ideas, and we understand that."

When Bill Foster (D-IL) asked what the Fed's timeline was for finalizing the liquidity rules, Powell said, "The main thing is we have this very large important project on Basel III, and I think we're pretty close to being able to move that out into the public view again. And once we've done that, we can move on to the other things that are there, and one of them is the liquidity proposals. I don't want to put a specific timeframe on it, but we're certainly working toward that sometime later this year, I would think."

Rep. Kim said she wanted to know if the Fed and other regulators had considered "the cumulative impact of any new liquidity standards with the Basel III framework and the existing post-crisis liquidity requirements." She specifically asked about "what industry engagement" the Board's staff has held regarding changes to the liquidity framework." Powell told her, "We haven't actually made any proposals on it yet. We have had significant industry interaction on the proposals and we will move, I think, at some time this year." When Kim inquired further about whether the Fed's staff has "conducted any industrywide data collection to study the necessity for and the impact of any changes to the existing liquidity framework," Powell said, "I think we've done a lot of investigation on that front, but I think that this is the beginning of the process, not the end. We haven't published proposals yet. We're working on them and it's a pretty early stage."

Debit card interchange fees. Nikema Williams (D-GA) asked about the Fed's Regulation II on debit card interchange fees, saying she had heard that the reduction in fees brought by the rule could affect "Bank On certified accounts in my district and across the country." (She described Bank On as a partnership between financial institutions and community organizations to offer low-cost or free bank accounts to unbanked and underbanked individuals.) Williams noted that she and Blaine Luetkemeyer (R-MO) had sent Powell a letter in March "urging that the final rule not negatively impact low- and moderate-income communities." She asked how the Fed takes such concerns into account when drafting regulations, especially for constituencies that cannot hire lawyers to write comment letters. Powell said, "We have heard those concerns that you raised and others have raised about aspects of the proposed rule … In terms of people who, where we don't have comment letters, we try to be thoughtful about the impact of our regulations, but principally we're looking for public comment on things."

Later, Mike Fitzpatrick (R-PA) said that despite the small-issuer exemption from the debit card interchange fee cap, "insurers with less than $10 billion of assets reportedly lost about 35% of inflation-adjusted interchange revenue." He asked if the Fed has considered the impact a further reduction of interchange revenue would have on smaller financial institutions with less than $10 billion in assets. Powell said, "That's another one where we put out a proposal. We got a lot of comments, and we're carefully reviewing those and we're certainly aware of the specific concern that you raised."

Long-term debt rule. Brian Fitzpatrick (R-PA) said he believed the bank regulators' long-term debt rule "should be rewritten and re-proposed as well, but at the very least, the rule needs to be tailored as the law requires so that regional banks aren't treated more harshly than the largest banks … In particular, the requirement for regional banks to hold long-term debt at both the holding company and insured depository institution [level], that seems to be a burden … I would hope that there would be some flexibility for smaller regional banks to pre-position resources because there are some resources that are loss-absorbing." Powell told him that regulators had put the long-term debt proposal out for public comment. "We've received quite a few comments, staff has been analyzing them, and … we're well aware of the concerns that have been raised and we're thinking carefully about how to move forward on that."

On pre-positioning, Powell said, "That's more along the lines of the discount window and the liquidity requirements … We haven't made a proposal there yet. We're thinking carefully about that. We're trying to learn the right lessons from what happened last spring at Silicon Valley Bank and a couple other banks. And one of them is [that] the discount window worked, but we could certainly modernize it and make it more effective. Also, we learned that bank runs are moving just a whole lot faster … even bank runs from 10 or 15 years ago were nothing like as fast as what happened in Silicon Valley. So, we need to bake that new learning into the liquidity requirements in some way or other."

Fed's discount window. Josh Gottheimer (D-NJ) said Congress has heard that the Fed's discount window "is behind the times in terms of its operations. We also continue to hear that efforts to modernize the discount window and encourage its use will be ineffective without reducing the associated stigma. The usability of the discount window is an important tool for banks that need liquidity." Gottheimer said he wanted to get a sense for any efforts under way to make the discount window "a more realistic option for banks that need liquidity." Powell said, "First, we need to modernize our infrastructure. The discount window in our system is not a primary source of credit; it's a source for banks that they can use under certain circumstances. We know that the infrastructure is a little tired, and we're investing in that and making it more user-friendly and all that. So that's a big, big project that's going on." Powell said the second point was the stigma that attaches to using the discount window. "When Congress required us to publish the names of discount window users, that didn't help. It doesn't help at all, because banks basically say, we're not going to use the discount window because … people might see us as troubled, and that's not what we want. We want people to be able to freely use the discount window. We've been focused on this issue for a long time. I have not made a lot of progress on it. But right now, I think we're very focused on it."

Dodd-Frank incentive comp rule. Nydia Velazquez (D-NY) asked for an update on the regulators' ongoing attempts, over many years, to agree on a rule restricting incentive compensation pursuant to Section 956 of Dodd-Frank. She said that in a June speech, SEC Commissioner Jaime Lizárraga said, "It has been well documented that, in the lead-up to the financial crisis, pay structures often encouraged big bets that maximized short-term profits but ignored bigger, longer-term risks that threatened to take down the entire financial system." She asked why the Fed had not signed on to an incentive-comp proposal approved by the FDIC and the OCC. Powell said, "The quote absolutely makes my point, which is … that incentive compensation practices for the global financial crisis were not in a good place. However, we published [non-binding] guidance on incentive compensation … for all banks in 2010 … a lot of thought went into that guidance, and now we supervise on that guidance. So the situation with incentive compensation now and banks is completely different than it was before the global financial crisis." Velazquez told him, "The other regulators have been able to figure this out and you haven't … this is not how congressional mandates work. Of all the rulemaking provisions in the Dodd-Frank, only 148 were mandatory, and of those, only 22 had a deadline of less than a year after enactment. Section 956 was one of them, and I hope that you come to the conclusion that it is your duty to issue the regulation." Powell told her that Section 156 actually "requires either a rule or guidance, by the way. It does not require a rule."

House stablecoins bill. Wiley Nickel (D-NC) said that "here in the House, in a bipartisan way, we've been working diligently to pass a bill to regulate payment stablecoins … . there have been numerous calls from this committee to you and to the Fed asking that you prioritize working with Congress to help push this legislation forward." He asked if Powell could commit to "directing your staff to finalize and support passage of stablecoin legislation this year." Powell said, "We think it's really important that we have a federal framework for stablecoins. And we'll be all-in on working with you to get that done."

Synthetic risk transfers to nonbanks. Bill Foster (D-IL) said that in the last few years, there has been increasing interest in synthetic risk transfers (SRTs) or credit-linked notes, "which are often used by U.S. banks to shift risk away from the banking system, and as a means of managing regulatory capital." Foster said he has been concerned by reports that the buyers of some of these SRTs may be investing in them using bank-provided leverage, "in which case, the risk can just boomerang right back into the banking system." He asked Powell to speak about "the ways that these investments can be a safe way for banks to offload risk, and in what ways they could become a dangerous source of contagion." Powell said, "There could be a breakdown in a couple of places in the chain, as you're obviously aware. One is just that the risk isn't really well and fully transferred to the buyer. And the first step is that risk going away off the balance sheet in an unconditional kind of a way, in a way that the bank understands. And that's a good thing if banks are able to do that. But then the question is, is it coming back through the back door with financing? … Banks do tend to bring these things to us, and we look at them carefully. We understand some of the ways it can go wrong. But at the end of the day, if it works to reduce the risk on a bank's balance sheet, that's something we should be OK with."

Foster expressed concern that the Fed would not have "insight and control" when the connection may go through nonbank entities that the Fed does not have direct oversight over. Powell said, "My understanding is that this is a very active dialogue we're having with banks. They want to know how this is going to be treated. They don't want to do something that is going to come back on them, or that we will deny the treatment on, so I think there's a pretty transparent set of exchanges around how these things work … we're very clear on what we think our requirements are."

Basel III's treatment of clean energy tax credits. As he has in previous hearings with Powell, Sean Casten (D-IL) asked about Basel III's treatment of clean energy tax credits available through the Inflation Reduction Act and other laws, noting that the original Basel proposal had assigned a quadruple risk weight to clean energy tax equity relative to other tax equity. "If there is a reproposal, can you give us any visibility on whether clean energy tax equity will go back to the 100% risk weighting that it's historically had?" Powell said, "I'm not going to give any specifics out today because you know … nothing's agreed till everything's agreed. So I don't want to get into what the specifics are." Casten said there are a lot of banks that want to participate in clean energy credits "that are … more cautious than they need to be right now."

'Project 2025.' Ranking Member Waters said that one goal of the Heritage Foundation's Project 2025 agenda "is to get rid of the Fed's dual mandate to promote stable prices but also maximum employment … If there was anything that would get rid of the mandate, what would it do to our economy?" Powell said, "The question of which mandate we serve is very much a question for Congress. My own view has been that the dual mandate has served us well. This is something Congress can change, and change back to a single mandate … " Waters then asked a series of questions about Project 2025's goals of eliminating diversity, equity and inclusion (DEI) policies in the government. She got Powell to say, "if you look at very successful American companies, you will very often see that … they're good at hiring, attracting, investing in and keeping diverse talent."

'Shrinkflation.' Ann Wagner (R-MO) noted that there has been reporting lately on "shrinkflation," the situation "when you pay the same price for something as yesterday but get less of it than before, kind of like my bag of potato chips." She said some people have tried to "direct attention away from the pain of runaway inflation that we've experienced and instead blame producers … yet I haven't seen any mention of shrinkflation as an inflation cause in any recent monetary policy report." Wagner asked if shrinkflation has been "a significant casual or amplifying factor in the runaway inflation of the past several years." Powell said, "I'd have to say no … packaging in the U.S. on food products … it's going to disclose the contents of the thing, and the price will be what it is and consumers can make their choice to buy it or not. But we don't think that's a major driver of inflation, no."