Musical Fed Board Chairs Post-Wyoming (Aug. 29)

Update 198 –- Musical Fed Board Chairs Post-Wyoming, All Over But the Yellen?

Fed Chair Janet Yellen delivered remarks on the state of financial stability on Friday in Jackson Hole, Wyoming at the Fed’s renown annual economic policy symposium.  Ten years after the onset of the Great Recession, the Chair took the opportunity to reflect on the impact of the Dodd-Frank Act (DFA) on the recovery of the financial system and economic growth since its enactment.

The speech comes as Janet Yellen enters the last six months of her turn at the helm of the Fed.  It makes clear that her re-appointment would be a vote for DFA, for systemic stability, and for continuity in the Fed’s program of monetary policy normalization.

This doesn’t sound one bit Trumpian, does it?  What is Trump’s alternative as Chair, a rate-raising inflation-phobic bond vigilante?  A free marketeer?  Where would current front runner for the post, NEC Director Gary Cohn fit in?  Let’s see.




The Wall Street Journal’s lead editorial today criticizes Chair Yellen’s Wyoming speech and the regulatory community for its advocacy of DFA.  The Journal appears to be mistaking for political activism the regulatory responsibility to implement the law.  Dodd-Frank and the rules it mandated that regulators implement was passed by an act of Congress and signed into law by the president of the United States — all of them elected officials.

In a three-part speech outlining the history of the great recession, the increased safety of the system, and the remaining challenges we face, Yellen articulated the successes of DFA.  In so doing, Yellen indicates no concern about the impact of her views on President Trump’s nomination of the next Fed Chair.

Her support for DFA’s structure may boost the prospects of National Economic Council Director Gary Cohn for the nomination.  Cohn has made strident statements against parts of DFA such as Orderly Liquidation Authority, the fiduciary rule, and capital requirements.  An appointment to lead the Fed might assuage any ambivalence of Cohn’s about serving the President as NEC director after chiding Trump for his post-Charlottesville comments.

How would the Fed look under a Chair Yellen vs. a Chair Cohn?  The two couldn’t be more different stylistically and substantively.  Yellen is a deliberate academic, the customary background of  Fed chairs.  Cohn is described as an instinctual thinker.  During the campaign, both Trump and Cohn criticized Yellen’s holding down interest rates for too long, but each maintain general support for loose monetary policy.  Other than his generic de-regulatory leanings, Cohn’s views on Dodd-Frank are not well-known.  We have more specific.  expectations he would promote greater supervisory changes than Yellen.

At a confirmation hearing, Cohn would no doubt be pressed for his views on the two chief assertions Yellen made regarding DFA at Jackson Hole — that it has contributed stability to the nation’s sustained economic recovery since its enactment in 2010 and has increased rather than retarded bank lending and economic growth.

Strong Evidence of Gains

Yellen pointed to specific indicators the financial system is healthier since the passage of the Dodd-Frank Act:

  • Capital Regimes — Loss-Absorbing Capacity – Large, interconnected financial institutions have more capital as a buffer against uncertainty.  Tier 1 common equity capital is more than twice the level of early 2009 across the entire banking system, a sizable increase stabilizing bank balance sheets.
  • Living Wills —  The most important financial firms have drawn up credible living will plans and changed their capital structure in a way that improves their resolvability.  The problem of Too-Big-To-Fail has been markedly and measurably reduced as a direct result.

Director Cohn has criticized heightened capital levels, believing they choke off lending to small and medium sized businesses.   He would be at pains to contradict Yellen’s finding that, “while material adverse effects of capital regulation on broad measures of lending are not readily apparent, credit may be less available to some borrowers, especially homebuyers with less-than-perfect credit histories and, perhaps, small businesses.”   The problem is by and large confined to the housing market.

Systemic Policy Pillars

Yellen attributed the above positive indicators to specific DFA policies:

  • Stress Tests (DFAST and CCAR) — DFA mandates that each year, Fed and company-administered stress tests must evaluate the health of systemically important financial institutions.  This policy has given firms the incentive to better structure their capital positions and risk-management processes.
  • Orderly Liquidation Authority (OLA) – OLA outlines a process for the Fed and FDIC-administered liquidation of a failing SIFI.  Yellen held up OLA as the preventer of Too-Big-To-Fail, as funds used to resolve the firm must be covered by the institution’s assets.

Director Cohn is not on record criticizing these policies, but may be inclined to oppose stress tests as too burdensome for banks.  He may also be aligned with Hensarling Republicans who believe OLA codifies, rather than eliminates Too-Big-To-Fail on the grounds that the systemic risk titles of DFA will be disregarded in a crisis.

Chair Yellen acknowledged that policymakers cannot rest on DFA’s laurels.  She outlined the following issues that need to be addressed:

  • Rules for Community Banks —Yellen did not specify which rules affecting smaller banks she would recommend changing, but legislation has been discussed in the Senate to except these institutions from escrow requirements, certain mortgage rules, and the Volcker Rule. It is widely understood that community banks and credit unions with fewer than $10 billion in assets are not systemically important.
  • Homebuyers’ Credit  (especially with weak histories) —  Yellen took this opportunity to expand on arguments about the relationship between high levels of capital and lending/credit availability.  She argued one cannot conclusively state that high capital requirements chokes lending, particularly in an environment just after a serious financial crisis, as behavior is likely to change.
  • Leverage Ratios —  Yellen cited a need to review supplementary leverage ratio with risk-based capital requirements – The SLR is meant to be a support to risk-based capital requirements. It limits the amount of leverage a bank may take on using a non risk-based measure. The rule is meant to account for the failure to accurately judge the risk of certain assets like residential mortgages.
  • Volcker Rule —  Yellen conceded that there “may be benefits to simplifying aspects of the Volcker rule, which limits proprietary trading by banking firms, and to reviewing the interaction of the enhanced supplementary leverage ratio with risk-based capital requirements.” Cohn might not disagree with this assessment.

The Cohn Factor

These are far from the kinds of critiques of DFA someone likely to win the favor of Trump might give.  Director Cohn may agree with or go further than Chair Yellen on all of the above.  He might argue the Volcker Rule should be eliminated, not merely simplified. Repealing the rule would return a sizable $1 billion in profits to Cohn’s former employer, Goldman Sachs.  He has attributed low credit availability to too-great capital holdings.  The only overlap between Yellen and Cohn are that they agree that regulations affecting smaller banks (along with big banks) should be simplified — a view that is almost universally held. Finally, Cohn might also advocate changes to the supplementary leverage ratio and risk-based capital requirements.

How far might a Chair Cohn go in promoting rollbacks of DFA?  In an interview in February, Cohn emphasized the following policy goals:

  • Increase capital availability (lending) to small and medium sized businesses
  • Decreasing regulations for banks of all sizes — Rather than focusing on relieving the regulatory burden on small institutions, Cohn stated that the burden is too great on firms of all sizes
  • Decreasing capital holdings — this aim directly contradicts Chair Yellen’s promoting a better-capitalized system of today
  • Repealing the DOL Fiduciary Standard — this rule requires financial advisors act in the best interests of their clients

The President has already nominated Randal Quarles for the post of Vice Chairman of Supervision.  Like Cohn, Quarles is bent toward deregulation, particularly of the Volcker Rule, stress test transparency, and rules affecting regional and community banks.

Yellen’s term ends in February.  At the end of July, Trump said he was considering both Cohn and Yellen for Fed Chair.   A poll of economists published by Bloomberg reveals that Cohn is more likely to be selected, though Yellen finished second. But a retirement by Yellen, an Obama appointee, would give Trump something to offer his base of support.  Trump’s decision will likely come early next year.

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