Update 810: Speaker’s FY 25 Budget Punt, Roundup

September 25, 2024 | Uncategorized | By

Update 810 — Speaker’s FY 25 Budget Punt,
CPI Drop, Fed Basel III Scale-Back Lead Week

House Speaker Mike Johnson on Wednesday withdrew his proposed Fiscal Year (FY) 25 Continuing Resolution (CR) to extend funding at current levels through Marchwith attached legislation redundantly barring non-citizen voting. Democratic leaders are awaiting a shorter-term CR, clean of policy riders, whether from Johnson or from the Senate. Congress, which has until the end of the month to enact a bill to forestall a government shutdown, made no progress this week.

CPI figures for August saw a slowdown in price increases, with annualized gains down to 2.5 percent. On Tuesday, Michael Barr, the Fed’s Vice Chair for Supervision, announced a major scaleback of the Basel III Endgame bank capital requirements proposal that federal banking regulators issued last year. Details are expected on September 19. We cover these and the other major economic policy developments of the week below.

Good weekends all…

Best,

Dana

Headline

CPI Inflation Falls to 2.5% in August

Last month, inflation as measured by the Consumer Price Index (CPI) fell to an annualized figure of 2.5 percent — its lowest level since February 2021 — signaling that inflation continues to move steadily toward the Federal Reserve Bank’s two percent target, according to the August CPI report which the Bureau of Labor Statistics released on Wednesday. 

Consumer prices rose by 0.2 percent on a monthly basis, on par with the previous month. Headline CPI fell on a year-on-year basis for the fifth consecutive month. Core CPI inflation – which excludes food and energy prices which can vary broadly – rose by 0.3 percent on a monthly basis and by 3.2 percent on a year-on-year basis in August. 

Source: Council of Economic Advisers

The shelter index – a measure of the cost of housing that comprises roughly a third of the overall index – rose by 0.5 percent on a monthly basis in August. Once again, the sector index topped the overall index in terms of price increases, accounting for over 70 percent of the total 12-month increase in headline CPI. Housing prices were slightly up from the 0.4 percent increase in the shelter index in July. Private sector data suggests that housing inflation will fall in future reports though the real current drop in housing inflation has yet to be fully reflected in CPI data. 

Food prices rose by 0.1 percent on a monthly basis in August, slightly down from the 0.2 percent increase in food prices during the prior month. Meanwhile, energy prices fell by 0.8 percent on a monthly basis in August after remaining unchanged in July. Contributing to this was the 0.6 percent decrease in gasoline prices and a 0.7 percent decrease in electricity prices. 

Inflation has fallen significantly from its peak of 9.0 percent in June of 2022 as it continues to fall toward two percent. This progress will surely reinforce Federal Reserve Chair Jerome Powell’s statements suggesting that the time is finally right to cut interest rates from the elevated 5.25 to 5.5 percent level when the Fed’s interest-rate-setting committee meets next week. 

In recent months, the labor market, which had been remarkably resilient in the face of the Fed’s rate hikes, has begun a notable cooling trend, with job gains moderating and unemployment rising. Fed Chair Jerome Powell has indicated that a cut is almost certain at the conclusion of the Federal Open Market Committee meeting on Wednesday, but it is not yet clear whether the committee will cut rates by 25 or 50 basis points.

Other Developments

House GOP Pulls FY25 CR, but Vote Slated for Next Week

On Wednesday, Speaker of the House Mike Johnson pulled his proposal for a Continuing Resolution (CR) from consideration on the House floor at the last minute, after failing to garner the Republican support necessary to pass the FY25 funding measure. The proposal, which would fund the government until next March at current levels, included controversial voting legislation requiring states to verify registered voters’ citizenship status (SAVE Act). 

The razor-thin Republican majority in the House has long caused problems for Johnson, who has struggled to find compromise between the right wing of his party and the moderates facing tough reelection contests. In this case, moderates were concerned about the House Freedom Caucus (HFC)-pushed SAVE Act, warning that its inclusion heightens the chance for a government shutdown ahead of the November elections as Democrats and the administration are adamantly opposed. Additionally, the six-month term does not have the support of some House Republicans, Democrats in either chamber, as well as Senate Appropriations Ranking Member Susan Collins (R-ME), who would like to see an extension until mid-December allowing members to complete full-year funding bills before the end of the 118th Congress. 

House Appropriations Ranking Member Rosa DeLauro (D-CT) has urged Johnson to engage in a four corners negotiation and abandon his partisan proposal. If he refuses, the Senate could still move forward with a (relatively clean) proposal of their own with a shorter timetable, likely their response to the House bill, which would not clear the upper chamber in its current form. 

Speaker Johnson remains hopeful that he can find agreement on his CR proposal within his own party, stating “We’re having thoughtful conversations, family conversations, within the Republican conference, and I believe we’ll get there.” If Johnson is able to unite his party, the House is likely to vote on the proposal next week, leaving very little time for the Senate to respond before adjourning for recess on September 27.

Fed Vice Chair of Supervision Michael Barr on Large Bank Capital Requirements

In a speech at the Brookings Institution on Tuesday, Federal Reserve Vice Chair of Supervision Michael Barr outlined plans to significantly roll back the capital requirement increases for the nation’s largest and most complex banks that had initially been proposed by federal banking regulators last year. Last year’s capital requirements proposals were designed to strengthen the financial system’s ability to withstand crises, like the one seen following the collapse of Silicon Valley Bank last spring.

The Basel III Endgame proposal – jointly put forward by the Fed, Federal Deposit Insurance Corporation (FDIC), and Office of the Comptroller of the Currency (OCC) last July – required stricter capital requirements on banking firms with $100 billion or more in total assets and firms that engage in significant trading activities. The original proposal would have effectively increased capital requirements by 19 percent for the eight U.S. Global Systemically Important Banks (G-SIBs). It would have increased capital requirements for the 37 biggest banks in the United States. That month, the Federal Reserve separately released its G-SIB Surcharge proposal which would help ensure that the largest, most interconnected U.S. banks maintain capital levels commensurate with their systemic footprint. 

Barr announced that he intended to recommend that the Federal Reserve Board re-propose the Basel endgame and G-SIB surcharge rules. He said that changes to the Basel III Endgame proposal have been a joint effort with officials at the FDIC and the OCC. Under these changes, broad and material adjustments would be made, including but not limited to: 

  • no longer subjecting banks with assets between $100 and $250 billion to the endgame changes, other than the requirement to recognize unrealized gains and losses of their securities in regulatory capital.
  • reducing risk-weights for residential real estate and retail exposures.
  • significantly lowering the risk weight for tax credit equity funding structures.
  • no longer adjusting a firm’s operational risk charge based on its operational loss history.
  • reducing operational risk capital requirements for investment management activities.

Taken together, the re-proposals would increase aggregate common equity tier 1 capital requirements for the G-SIBs by 9 percent. For large banks that are not G-SIBs, the impact from the re-proposal would mainly result from the inclusion of unrealized gains and losses on their securities in regulatory capital, estimated to be equivalent to a 3 to 4 percent increase in capital requirements over the long run.

The announcement of significant rollbacks comes after Fed Chair Jerome Powell met behind closed doors with the CEOs of some of America’s largest banks, including JPMorgan Chase’s Jamie Dimon and Citigroup’s Jane Fraser. The banking industry has lobbied extensively against the Basel III Endgame proposal since it was proposed despite its potential to significantly enhance financial stability. 

Text of the proposed changes could be released as soon as Thursday, according to recent reporting by Bloomberg. Barr said that he expects an open board meeting will be scheduled after he makes his recommendations, following which the recommendations will be put out for public comment over 60 days. After this comment period, regulators will analyze comments before moving forward to finalization.

Hearings

Senate Finance on the Road Ahead for Tax Policy 

The Senate Finance Committee convened for a hearing on Thursday to discuss tax policy ahead of next year when the individual and estate provisions of the Tax Cuts and Jobs Act expire. Finance Chairman Ron Wyden (D-OR) opened the hearing by designating next year’s tax debate as a “make or break moment for the federal budget and for America’s middle class.” Across-the-board extensions of the Trump-era policy would cost $4.6 trillion over 10 years, according to the Congressional Budget Office (CBO). 

Chairman Wyden and other Democratic Senators argued the importance of raising revenue, not only to promote a fairer tax code but also to address key funding needs in areas like healthcare and housing. He reminded his colleagues of the Trump playbook on tax, noting that his proposals for more than $7 trillion in tax cuts would give wealthy individuals hundreds of dollars in tax savings for every dollar received by the lower or middle class. 

The hearing also focused on tactics the wealthy use to avoid paying taxes, including the Buy, Borrow, Die loophole (wealthy individuals borrowing against their unrealized assets, which are subsequently passed on tax-free at death), GRATs, and IRAs. In the eyes of progressives, the ability of the wealthy to engage in tax avoidance perpetuates unfairness in a tax code that is already skewed towards the wealthy. 

Ranking Member Mike Crapo (R-ID) pointed to the large share of tax revenue already generated from wealthy individuals, despite their common use of tax avoidance tactics. He also called out Democrats lack of clarity surrounding their plans for the expirations, noting that the trillions of dollars in “tax hikes” from letting TCJA provisions expire would also come from those who make less than $400K a year, something that Democrats have vowed to avoid but have yet to explain how. 

Ranking Member Crapo, joined by his Republican colleagues and the more conservative witnesses, argued in favor of the economic benefits generated by the TCJA, an argument we will hear much more of as we approach next year’s tax debate. While the evidence is a bit skewed by the COVID-19 pandemic and associated economic shocks, there is little sign that the policy “paid” for itself in economic gains.

Senate Budget on SSA Approps., Soc. Security Solvency

On Wednesday, the Senate Budget Committee held a hearing to assess short and long-term funding shortfalls facing the Social Security Agency (SSA) and explore opportunities for reform. In their opening statements, Budget Chair Senator Sheldon Whitehouse (D-RI) reiterated the Democratic commitment to preserving Social Security without cutting benefits while Ranking Member Chuck Grassley pleaded for a bipartisan approach to reform, likely hinting at a combination of revenue increases and benefit cuts to address impending insolvency. 

The hearing consisted of two panels, the first featuring SSA Commissioner Martin O’Malley who testified to the current problems facing the agency as it attempts to serve more beneficiaries than ever before with its lowest staffing levels in 50 years. The Commissioner praised President Biden’s FY25 budget, which includes $15.4 billion for the SSA in annual appropriations. According to O’Malley, this strong financial commitment is necessary for the program to address staffing issues and continue to improve customer service. 

The second panel of the hearing focused on the longer-term shortfalls facing Social Security, which is projected to reach insolvency in 2034 resulting in a roughly 25 percent cut in scheduled benefits. Democratic Senators and liberal-leaning witnesses praised Chairman Whitehouse’s Medicare and Social Security Fair Share Act, which would extend Social Security solvency indefinitely by reinstating the FICA payroll tax on income over $400,000 and enacting a Net Investment Income Tax (NIIT) for wealthy individuals. Currently, income over $168,600 is exempted from the payroll tax that funds Social Security, and there is no NIIT (there is a 3.8 percent NIIT for Medicare, and Vice President Harris has proposed expanding it to 5 percent).

Conservative members warned of the impact that increasing payroll taxes could have on work incentives and noted that wealthy individuals already get less of a share of the money that they pay in than those on the lower end of the income spectrum. 

Look Ahead

Tuesday, September 17

Wednesday, September 18

  • Federal Open Market Committee (FOMC) meeting (Day 2)

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