Four top federal regulators ― including two Democrats ― urged the Federal Reserve last month to weaken a key post-crisis rule limiting risk-taking at the nation’s six largest banks. If successful, the bipartisan effort would boost short-term bank profits but render the financial system vulnerable to another crash.
At issue is the supplementary leverage rule, which was adopted in the aftermath of the 2008 collapse as a last line of defense against financial excess. While most banking rules involve a dizzying array of technical definitions, exceptions and complications to account for different risks, the leverage rule was designed to be a simple, blunt instrument.
At the most basic operational level, banks get into trouble when they rely too heavily on borrowed money to “leverage” their own capital. The more borrowed money banks use, the bigger their profits during a boom and the larger their losses in an unforeseen downturn. Regulators impose leverage requirements in order to reduce the amount of borrowed money banks can put into play.
But four out of five top officials at the Commodity Futures Trading Commission want the Fed to lower leverage requirements by changing the way the officials treat derivatives ― complex financial instruments that banks buy and sell on behalf of other institutional clients. Two of the four regulators, Rostin Behnam and Dan Berkovitz, were handpicked by Sen. Chuck Schumer (D-N.Y.) to fill the agency’s dedicated slots for Democrats. The fifth commissioner, Dawn Stump, recused herself from commenting on the rule.
In the years since the banking crash, even Republicans have been reluctant to openly call for looser regulations on the largest banks. Wall Street’s advocates in Washington typically point to the assistance that deregulation will provide to small banks, or blame federal regulators for problems instead of the banks they oversee.
But that posture may be changing. Trump Treasury Secretary Steven Mnuchin endorsed a plan to lower leverage requirements for big banks in 2017. At a congressional hearing last week, Reps. Sean Duffy (R-Wis.) and Roger Williams (R-Texas) defended the scandal-plagued banking behemoth Wells Fargo, deriding its critics as advocates of “socialist banking” and “socialism.” Last month, five Republican Senators led by Thom Tillis (R-N.C.) wrote to the Government Accountability Office, seeking to build a case for repealing regulatory guidance on the largest banks through the Congressional Review Act.
And at least some Democrats appear to be joining the deregulation push. Derivatives typically function as a sort of bet on economic activity ― a gamble that the price of a financial asset will move up or down. When banks trade derivatives for hedge funds or other investors, they are required to charge a small up-front fee called “margin,” which the bank can use to help cushion any losses should their clients be unable to pay up. Berkovitz, Behnam and Republican Commissioners Christopher Giancarlo and Brian Quintenz argue that this margin should be excluded from leverage calculations, increasing the amount of borrowed money banks can put into play under existing leverage requirements.
Including margin, the bipartisan team of regulators argued, discourages banks from trading derivatives through central clearinghouses, which is a safer and more transparent way to trade. Central clearinghouses guarantee the ability of each bank to make good on their bets, helping prevent a default from a bank from cascading through the financial system. The CFTC Commissioners argued that the current rule is “working counterproductively” and producing “an inflated measure” of a bank’s overall “exposure” to trouble.
Lobbyists for big banks have been making this argument for years, but data from the Office of the Comptroller of the Currency tells a different story. In recent years, banks have increased the proportion of derivatives they send through a central clearinghouse.
Financial reform advocates, meanwhile, note that other CFTC rules flatly require risky types of derivatives to go through a clearinghouse, while separate requirements on bank capital can be tailored to encourage or discourage particular types of trading.
“The idea that lowering their leverage requirements will make the system safer ― that’s a really incredible thing for federal regulators to say,” said Gregg Gelzinis, a policy analyst at the Center for American Progress, a liberal-leaning think tank. “Carving up the leverage ratio and lowering the equity buffers at Wall Street banks will only increase the likelihood of another crash.”
The Federal Reserve, the OCC and the Securities and Exchange Commission have final say over leverage requirements, and are currently in the process of rewriting the rules. Both the Fed and the SEC are stacked with Trump appointees friendly to big banks, but support within the agencies is not uniform. Fed Chairman Jerome Powell and Vice Chair Randall Quarles approved of reducing leverage requirements last year, while Lael Brainard, an Obama appointee, did not. Public support from two Democratic regulators at the CFTC changes the dynamic in Washington, helping insulate the Fed’s deregulation advocates from criticism.
But at least some Democrats in Congress are crying foul. Rep. Katie Porter (D-Calif.) was a bank regulation scholar for years before she ran for Congress last year, and has been a scourge of financial heavyweights from her new post on the House Financial Services Committee. In a statement provided to HuffPost, Porter excoriated the plan to weaken leverage rules as “another example of Trump regulators listening to Wall Street’s wish list.”
“Between this, the banking deregulation bill passed last year, and other changes proposed by the Fed and OCC, we can expect Too Big to Fail banks to get riskier and have less of a cushion to guard taxpayers from bailouts,” Porter said.