Now that the Democrats have won a significant majority in the House, it is important that all legislators remember that they are there to serve their constituents. There are few better ways to serve taxpayers than making sure that the banking system does not implode and cause taxpayer bailouts. Current attempts to weaken bank regulations and supervision of banks, especially this late in the expansionary part of the credit cycle, poses significant risks to the global economy and to Main Street USA.
On October 31st, the Federal Reserve released a proposal that banks between $250 – 700 billion in assets would be subject to weaker liquidity and stress testing requirements. After living through several financial crisis in the 1990s and in 2007-2008, I am absolutely convinced that there is no need for bank regulators to weaken requirements for large regional and foreign bank organizations. As I have proposed in previous columns, this is the time for bank regulators to ask banks to allocate more capital to help them weather a future downturn.
Big banks and their lobbyists often argue that Basel III capital, liquidity, and leverage requirements, along with Dodd-Frank’s Comprehensive Capital Assessment Review and Stress Test requirements, have reduced their ability to lend to individuals and companies. The data strongly contradict those claims.
The Federal Reserve Bank of New York’s Quarterly Report on Household Debt and Credit shows that household debt has risen for sixteen consecutive quarters. American households’ now have indebtedness of $13.29 trillion, which is $618 billion (5%) higher than the previous peak in the third quarter of 2008 of $12.68 trillion. Household debt is presently about 19% higher than the trough in the second quarter of 2013.
Commercial and industrial(C&I) loans underwritten by banks have also grown substantially. Bank loans to companies have grown 38% since the peak before the crisis in 2008. Since eight years ago when loans to commercial and industrial entities were at a trough, C&I loans have grown over 80%.
The household and company debt that I have described is underwritten by banks. There are also numerous non-banks, or what are often referred to as shadow financial institutions, which also lend to households and businesses. A centralized data source for all those non-bank loans is much harder to come by. What we really should be worried about should be whether those non-bank loans have strong covenants to protect creditors, especially when we enter a downturn.
The level of U.S. bank earnings are also very important to evaluate. If bank regulations are so detrimental, why has this year been so great for bank earnings? Yes, banks have been helped by tax reforms. Yet, their earnings started improving before the new tax law. In 2013, and 2016, bank earnings hit post crisis highs several times. This year, banks again broke earnings records both in the first and second quarter this year. Banks’ third-quarter earnings were also very strong. Every time I write bank lobbyists to show me how bank regulations are hurting their earnings, I have yet to receive a response.
Important financial reformers such as Americans For Financial Reform and Better Markets have expressed concerns to bank regulators asking that rules for large banks not be weakened. Marcus Stanley, Policy Director of American for Financial Reform stated that the Federal Reserve’s proposals “go well beyond anything required by Congress, and significantly weaken requirements for large banks to hold cash and easily salable liquid assets to satisfy payment requirements in times of economic stress.” He also pointed out that the regulators “themselves admit that these changes would increase the likelihood of liquidity-related bank failures.”
Better Markets President and CEO, Dennis Kelleher, stated that the Federal Reserve’s proposals to weaken big banks’ liquidity and stress testing requirements “are as unjustified as they are unwise. Deregulating some of the largest banks in the country will make the financial system less safe, less stable and less protected from another crash.” As I have warned in previous columns, Kelleher emphasized that to weaken regulations “so late in the business cycle after a $2 plus trillion of fiscal stimulus when these banks have record revenues, profits and bonuses is needlessly gambling with taxpayers’ money.” Kelleher recommended that the Federal Reserve should be imposing “countercyclical buffers, increasing capital, liquidity and other safeguards” on big banks.
Also important is the fact that global rating agencies such as Standard and Poor’s and Moody’s have stated that weakening bank requirements is a credit negative for bank bond investors. In a report published yesterday, Standard and Poor’s Senior Director, Stuart Plesser, wrote that the Fed’s proposals are incrementally negative for bank creditors but that “because the proposal’s more substantive changes in regulation only targets banks holding roughly 15% of the assets in the U.S. banking system, and is targeted for the banks the regulators deem less risky.”
Moody’s also released a report stating that this proposal is a credit negative. Specifically, on October 31st, Moody’s report warned that “the reduced frequency of capital and liquidity stress testing could lead to more relaxed oversight and afford banks greater leeway in managing their capital and liquidity, as well as reduce transparency and comparability, since fewer firms will participate in the public supervisory stress test.”
My concern is that when we get into a downturn, these banks may find themselves insufficiently capitalized or liquid enough to withstand how quickly their lenders and other market participants can panic. When banks’ counterparties panic, they will quickly stop lending to banks, ask for more collateral, and close out positions, making banks quickly illiquid and increasing banks’ borrowing costs, which in turn makes them even less liquid and possibly insolvent. I urge legislators and regulators not to forget the lessons from previous financial crises, especially the one in 2008. It is in the good times that we need to compel banks to get ready for the downturns.