Update 345 — HFSC Megabank CEO Hearing:
Private Custodians of Public Systemic Risk
The CEOs of the nation’s biggest financial institutions will meet on Capitol Hill tomorrow for the first time since the financial crisis for a House Financial Services Committee hearing. The purpose of this unusual gathering is to hold the firms these CEOs lead accountable for… Well, it is target-rich territory, to say the least.
The CEOs should be held most accountable for the prodigious financial systemic risk their firms can and have visited on the American economy. In an honest moment, witnesses will concede that some risk levels are increasingly and concerningly approximating those pre-crisis, identify the riskiest current megabank practices, and suggest regulatory benchmarks to hold themselves accountable.
With star witnesses and a panel of eager Democrats in the majority, including some voluble freshmen members, the hearing could establish some benchmarks of accountability and should make good theatre.
Tomorrow, the House Financial Services Committee (HFSC) will hold a hearing entitled, “Keeping Megabanks Accountable,” featuring seven CEOs of the eight Global Systemically Important Banks (G-SIBs), minus Wells Fargo. The hearing will be the first convening of the G-SIB CEOs before Congress since 2009.
The G-SIBs have a combined $11.1 trillion in assets, totaling about half of all domestic banking assets. Much of the systemic risk in the financial system lies in the balance sheets of these CEOs firms.
Sectoral Competitiveness and Concentration
The seven G-SIBs represented tomorrow occupy a large share of the financial market, so concentration will be a featured topic. Over the last few decades, financial concentration in the U.S. has grown at a steady clip. In the 1980s, the five largest U.S. banks made up 29 percent of the total U.S. market share, or 14 percent of GDP. Today, they make up more than 50 percent of the total U.S. market share, or 86 percent of GDP.
In 2008, the four biggest U.S. banks — three of which will be represented tomorrow — controlled over half of American mortgage loans and credit card accounts. Though the share of the mortgages market held by the four biggest banks dipped to under 50 percent in 2017 with the rise of nonbank mortgage lending, the share of credit cards issued by the four U.S. banking giants climbed to 57 percent in 2017.
Since 1999, the total number of banks dropped by about two-thirds to where it is today — about 5,000. Despite high barriers to entry and consolidation into bigger firms, small community banks continue to get favorable treatment by lawmakers, and they were the main purported beneficiaries of the regulatory rollback bill, S. 2155.
Community banks compete with Wall Street giants but also benefit and suffer symbiotically. Concentration, both vertically up from these small banks and horizontally between larger firms, can encourage risky behavior, complicate monetary policy, and dry up competition. Given the recent SunTrust/BB&T merger announcement, lawmakers are likely to bring up concerns about excessive concentration in the U.S. banking sector during tomorrow’s hearing.
Whither TBTF Today?
Too-Big-To-Fail (TBTF) firms were at the heart of the financial crisis. These large banks and other financial institutions were so interconnected and loaded with bad debt that their failures threatened to wreak unprecedented havoc on the US and global economy. As a result, US taxpayers spent hundreds of billions of dollars bailing them out. When Congress passed DFA in 2010, it aimed to end TBTF.
The International Monetary Fund stated in 2014 that TBTF has intensified since the financial crisis and that banks deemed ‘too important to fail’ increasingly borrow at lower rates and take bigger risks. Democratic lawmakers will likely bring up these issues during tomorrow’s hearing, and witnesses will have prepared responses to new calls for enhanced prudential standards.
Wall Street cheered on S. 2155, the sweeping deregulatory bill passed last year, in particular praising their long-sought reductions in capital and liquidity requirements. With lower leverage and capital standards, big banks can incur more debt and have more investment flexibility. Witnesses will likely argue that federal regulations on capital and liquidity hamper their ability to lend and achieve growth. Inhibiting risks, they will say, decreases profit.
But none of these witnesses will deny that enhanced prudential regulation in DFA has made the financial system safer, and with bank profits higher than they have ever been, it is increasingly difficult to take their concerns about profitability trade offs seriously.
Systemic Risk: Pride Before a Fall?
In his annual missive to shareholders last week, JPMorgan CEO Jamie Dimon noted the turmoil in the financial markets at the end of 2018 as “a harbinger of things to come.” Despite this, in the letter, Mr. Dimon also argues that policymakers should ease capital requirements for banks, including the G-SIBs, making the case that “certain products and services will continue to be pushed outside the banking system… raising the cost of credit for clients.”
On March 6, Fed Governor Lael Brainard was the lone Fed Board member to vote in favor of increasing the countercyclical capital buffer (CCyB) from its current level of zero. During a December 2018 speech at the Peterson Institute, Brainard argued that large banks needed to augment their capital buffers because stress tests alone have limitations, and the megabanks can clearly afford it. She explained how the Fed needs to “serve as a counterweight” during good economic times, because market forces will likely not provide incentives for banks to increase their capital buffers at the peak in the economic cycle “when risk is [arguably] the highest.”
Tomorrow’s hearing will be a chance for lawmakers to pin down the heads of the big banks on their view of current systemic and concentration conditions. The big banks are just as interconnected as they have ever been and TBTF remains unsolved nine years after Dodd-Frank.
On all fronts, regulators are slowly, but surely, lowering the bar for the big players on Wall Street, and the direction of the administration suggests there is more to come. The G-SIB heads seem overly confident about their ability to weather a financial crisis, but Democratic representatives who have seen this type of hubris before will no doubt express their incredulity tomorrow morning.