How Stable is Wall Street?

Update 384 —  How Stable is Wall Street:
In a Downturn, Would TBTF Be Tested?

With the nation’s economy showing signs of cooling off, attention naturally turns to the epicenter of the last financial crisis.  How would the Street — and, as a result, the system — fare if things go much further south?

A key Congressional subcommittee heard from a Fed Governor and the new Director of the Office of Financial Research on the question yesterday.  The amount that we don’t know is by itself a cause for concern. We look at the problems involved and proposals under discussion. 




Yesterday, the House Financial Services Subcommittee on Consumer Protection and Financial Institutions held a hearing entitled “Promoting Financial Stability: Assessing Threats to the U.S. Financial System.”  The two witnesses were Dino Falaschetti, the new Director of the Office of Financial Research (OFR), and Fed Governor Lael Brainard. 

The hearing comes as the longest economic expansion in U.S. history begins to show signs of fatigue, with several risks to financial stability now appearing — some new, some chronic and worsening.  Meanwhile, Trump-appointed regulators are engaged in what former Fed Governor Dan Tarullo call a “low-intensity deregulation, consisting of an accumulation of non-headline-grabbing changes and an opaque relaxation of supervisory rigor.” 

The pursuit of “low-intensity deregulation” is akin to the boiling frog fable; is the American economy being slowly overheated (deregulated)?  Former and current regulators as well as progressives in Congress seem to think so. It is in this deregulatory environment that we consider clear and present dangers as well as the systemic and TBTF risks that do not announce themselves in advance. 

Yesterday’s hearing was intended to shine a light on the emergent risks to financial stability.  More on the risks identified and the regulatory and legislative responses below… 

Known Financial Risk: Corporate Debt

In May’s Financial Stability Report, the Fed noted the “historically high” levels of corporate debt as a potential risk to financial stability.  While overall debt levels are a cause for concern, the creditworthiness of the borrowers in the corporate sector is deteriorating. The report explains, “growth in business debt has outpaced GDP for the past 10 years, with the most rapid growth in debt over recent years concentrated among the riskiest firms.” 

Per research by S&P Global, nearly 80 percent of outstanding subprime corporate debt — or “leveraged loans” — in the U.S. are “covenant-lite,” leaving lenders with inadequate protection in the event borrowers default. In response to a question by Subcommittee Chair Gregory Meeks, Fed Governor Lael Brainard remarked on the lack of proper covenants as a cause for concern; “What is notable is that the covenants on those leveraged loans have weakened relative to what they would have looked like historically. There are features that make them less secure and more opaque.” 

Subprime corporate debt and leveraged lending are issues we have covered before, and they were a main focus during yesterday’s hearing. Just the mention of “subprime” debt elicits painful memories for many, ten years after the subprime mortgage crisis precipitated the Great Recession.  Both Fed Chair Powell and Vice Chair Quarles have recently sought to allay concerns that there is any systemic risk to banks, arguing that much of the risk in the secondary market is outside of the financial system.  

But others are less sure about where the risk actually lies.  Gov. Brainard drew attention to this opacity in the leveraged loans market to regulators; “We [the Fed] need to have as much visibility as we can in those structures — and who is holding them.”

Progressive Regulatory Response 

  • FSOC Reform

    Last October, the Financial Stability Oversight Council de-designated Prudential Financial Inc. as a systemically important financial institution, or SIFI. As a result, no nonbanks are currently designated as systemically risky and subject to enhanced oversight, leaving the shadow banking system free to operate in the shadow virtually without regulatory scrutiny.

    A Discussion Draft of a bill to reform the FSOC in a way that breathes new life into its critical regulatory and oversight function was considered during the hearing. The bill, sponsored by Rep. Chuy Garcia, would reform FSOC’s non-bank designation process by automatically designating nonbank financial companies based on a size threshold and one additional quantitative risk metric.  

    The bill also gives FSOC direct rulemaking authority over systemically risky activities, increases funding and staffing requirements for both FSOC and OFR, and increases transparency by requiring FSOC meeting transcripts to be released on a five-year delay, mirroring current practice for FOMC meeting releases. 

    During the hearing, Gov. Brainard said that nonbank activity continues to be an important source of systemic risk. But without adequate oversight and information, regulators are looking at a black box.  The Subcommittee’s Discussion Draft bill flips the default position of no designation to automatic designation, putting the onus on FSOC to de-designate, giving the Council and other primary regulators much needed visibility into non-bank financial institutions, while still leaving them with a de-designation off-ramp. 

    Not included in the formal Discussion Draft, but hinted at by market observers as a way to address problems with the current designation-first, data-later approach: an intermediate level of non-bank designation —  an antechamber for firms being considered for SIFI designation, providing regulators with adequate data and systematic reporting of the managed assets and liabilities of non-bank finance companies so as to provide better visibility into a firm’s proper SIFI status. 
  • Countercyclical Capital Buffer 

    Gov. Brainard testified that corporate debt market risks could amplify any unexpected shocks to the economy, describing how a vicious cycle could occur: over-indebted businesses could face payment issues if earnings fall short; subsequently, they may pull back on investment and hiring, reducing investor appetite for risky assets. A counter- cyclical capital buffer operates as a kind of rainy day insurance for the sector. 

    Gov. Brainard made the case that large banks needed to augment their capital buffers, using the Fed’s countercyclical capital buffer (CCyB), because stress tests alone have limitations, banks can afford it, and it is the right time in the cycle to do so. She noted that the Fed Board voted to set the CCyB at zero earlier this year, even as many other central banks around the world have raised theirs above zero.

    Brainard’s colleagues at the Fed differ over whether or not the CCyB should be turned on. Back in July, at a Bipartisan Policy Center Event, Fed Governor Quarles argued that “our CCyB is effectively on because we have such high capital in the banking sector.” 

    Despite Quarles’ claims, on average, the six largest banks have less than $7 for every $100 in assets. Research by economists at the Minneapolis Fed suggests that this would not even be half of what would be needed to avert future bailouts. Given this, how can taxpayers rest assured that they will not be on the hook yet again when (not if) the next crisis hits? 

TBTF and the Data Problem

A lot of focus during yesterday’s hearing was on arguably transient market conditions like last week’s Repo market liquidity crisis rather than fundamental and on-going systemic risk issues. Gov. Brainard warned that while the Dodd-Frank Act’s far-reaching reforms have made the financial sector stronger than before 2008, we must remain vigilant and “fortify financial system resilience” before deregulation induces history to repeat itself.  

Although history can only tell us so much, reliable warning signs such as excessive leverage and subsequent exposure by banks and other less-regulated financial firms are beginning to emerge. This raises a crucial question: do we have not just the regulatory tools and levers to identify systemic interconnection TBTF risks and at-risk firms, but the data to diagnose?  

Without data, without designation, we remain subject to TBTF, another crisis, perhaps another bailout that is, to repeat history, having learned little. 

59 thoughts on “How Stable is Wall Street?”

  1. Have you ever thought about creating an e-book or guest authoring on other blogs?

    I have a blog centered on the same ideas you discuss and would
    love to have you share some stories/information.
    I know my audience would enjoy your work. If
    you’re even remotely interested, feel free to shoot me an e mail.
    0mniartist asmr

  2. Link exchange is nothing else however it is just placing the other person’s web site link on your page at
    suitable place and other person will also do same in favor of you.
    asmr 0mniartist

  3. I’m extremely inspired with your writing abilities and also with the layout to your
    blog. Is that this a paid theme or did you customize it
    your self? Anyway keep up the excellent high quality writing,
    it is uncommon to peer a great blog like this one nowadays..
    0mniartist asmr

  4. We are a group of volunteers and opening a new scheme in our community.
    Your web site provided us with valuable information to work on.
    You have done a formidable job and our whole community will be grateful to you.
    asmr 0mniartist

  5. Its like you read my mind! You seem to know so much about this, like you
    wrote the book in it or something. I think that you can do with some pics to drive the
    message home a bit, but other than that, this is magnificent blog.
    An excellent read. I’ll definitely be back.

    My web-site :: ok388 ios download (Sherryl)

  6. I’m extremely inspired with your writing abilities and also with
    the format in your blog. Is that this a paid subject matter or did you customize
    it your self? Either way stay up the nice high quality
    writing, it’s uncommon to look a nice weblog like this one today..

    my web-site :: download 918kiss plus android;,

  7. When I initially commented I clicked the “Notify me when new comments are added” checkbox and
    now each time a comment is added I get four emails with
    the same comment. Is there any way you can remove me
    from that service? Thank you!

  8. Thanks , I have recently been searching for information about
    this subject for a while and yours is the greatest I’ve found out so far.
    However, what in regards to the conclusion? Are you certain about the

  9. I am really enjoying the theme/design of your weblog.

    Do you ever run into any web browser compatibility issues? A
    handful of my blog audience have complained about my blog not working correctly in Explorer but looks great in Safari.
    Do you have any solutions to help fix this problem?

  10. Excellent goods from you, man. I’ve understand your stuff previous
    to and you’re just too fantastic. I really like what you’ve acquired here, really like what
    you are saying and the way in which you say it.
    You make it entertaining and you still care for to
    keep it sensible. I can not wait to read much more from you.
    This is really a wonderful site.

  11. I’m not sure why but this blog is loading extremely slow for
    me. Is anyone else having this issue or is it a issue
    on my end? I’ll check back later and see if the problem still exists.

  12. Thanks for sharing your thoughts. I really appreciate your efforts and I will be waiting
    for your next write ups thank you once again.

  13. Greetings from Los angeles! I’m bored to death at work so I decided to check out your site on my iphone during lunch break.
    I love the information you present here and can’t wait
    to take a look when I get home. I’m amazed at how fast your blog loaded on my phone ..

    I’m not even using WIFI, just 3G .. Anyways, awesome

  14. scoliosis
    Hi there are using WordPress for your site platform?
    I’m new to the blog world but I’m trying to get started and
    create my own. Do you need any coding expertise to make your
    own blog? Any help would be greatly appreciated!

  15. scoliosis
    I really love your website.. Pleasant colors & theme.

    Did you create this site yourself? Please reply back as
    I’m wanting to create my own site and would like to learn where you got this from or exactly what the theme is called.

    Cheers! scoliosis

  16. dating sites
    My partner and I absolutely love your blog and find
    many of your post’s to be exactly I’m looking for. Does one offer guest
    writers to write content available for you? I wouldn’t mind publishing a post or elaborating on some of the
    subjects you write related to here. Again, awesome website!
    free dating sites

  17. Hey I know this is off topic but I was wondering if you
    knew of any widgets I could add to my blog that automatically tweet my newest
    twitter updates. I’ve been looking for a plug-in like this
    for quite some time and was hoping maybe you would have some experience with something like this.
    Please let me know if you run into anything.
    I truly enjoy reading your blog and I look forward
    to your new updates.

  18. Have you ever thought about writing an ebook or guest authoring on other websites?
    I have a blog based on the same subjects you discuss and would love to
    have you share some stories/information. I know my readers would value your
    work. If you are even remotely interested, feel free to send
    me an e mail.

  19. Admiring the commitment you put into your site and detailed information you present.
    It’s awesome to come across a blog every once in a while
    that isn’t the same out of date rehashed information. Excellent read!
    I’ve bookmarked your site and I’m including your RSS feeds to my Google account.

  20. Howdy just wanted to give you a quick heads up. The words in your article seem to be
    running off the screen in Safari. I’m not sure if this is
    a format issue or something to do with web browser compatibility but I thought I’d post to let you know.
    The design look great though! Hope you get
    the problem solved soon. Thanks

  21. Great post. I used to be checking constantly this blog and I’m inspired!
    Very useful info particularly the ultimate phase 🙂 I care for such info a
    lot. I used to be seeking this particular information for a long time.
    Thanks and best of luck.

  22. Hi are using WordPress for your blog platform?

    I’m new to the blog world but I’m trying to get started and
    create my own. Do you require any html coding expertise to make your own blog?
    Any help would be greatly appreciated!

  23. Pingback: healthy keto recipes

Leave a Comment

Your email address will not be published. Required fields are marked *