Lawmakers Officially Forget the Financial Crisis
Now it’s up to the Fed to prepare for the next one.
The U.S. Congress might have just set a record for shortness of memory: Just 10 years after a crisis that nearly brought down the global financial system, it’s loosening the safeguards designed to prevent a repeat. Now it’s up to regulators — and specifically the Federal Reserve — to ensure that the backsliding doesn’t go too far.
Prodded by President Donald Trump to “do a big number” on the 2010 Dodd-Frank reform, the House and Senate have agreed on a bill, the Economic Growth, Regulatory Relief, and Consumer Protection Act. It’s not a major rollback, and it provides some welcome relief for community banks, but it does take aim at a crucial guarantor of financial resilience: the equity capital that allows banks to absorb losses in difficult times.
The bill eases capital requirements for “custodial” institutions such as State Street and Bank of New York Mellon. These are among the most systemically important because they facilitate other banks’ transactions. What’s more, it does this by complicating a key measure of capital, known as the leverage ratio, which is meant to be a simple supplement to more easily manipulated regulatory metrics.
The bill also frees regional banks with less than $250 billion in assets from company-run stress tests and from special Fed supervision. That threshold is too high: Many of those banks are large, and institutions in this category required billions of dollars in taxpayer support to get through the last crisis.
The changes could be viewed in a more positive light if the banks had plenty of capital. They don’t. Some barely squeaked by in the last round of stress tests, and the largest have as little as $6 in equity for each $100 in assets — not nearly enough to avoid distress in a severe crisis. The loosening is also poorly timed: risks in the financial system are mounting, and banks have been reducing their reserves against bad loans.
If none of this worries legislators, it should concern the Fed. The central bank is responsible for ensuring the stability of the banking system, and has been granted the necessary powers. It can, for example, increase capital requirements in exuberant times to help prepare banks for the inevitable downturn. Even under the new bill, it can impose added scrutiny on banks with less than $250 billion in assets, effectively bringing the threshold down to a more reasonable $100 billion.
Lately, though, the Fed has been considering easing off on capital demands, much as it did ahead of the last crisis. This is unfortunate. If the Fed won’t retain an institutional memory of the 2008 debacle, who will? A forgetful Congress is bad enough. The economy can’t afford to see the Fed go the same way.
—Editors: Mark Whitehouse, Clive Crook.
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