Stress tests, as we’ve detailed here, have been invaluable in strengthening our financial system. They are vital tools that protect taxpayers and our economy by making sure that banks have enough capital to absorb their own losses without needing bailouts. They must continue to be robust and credible.
That’s the message Better Markets President and CEO Dennis Kelleher told academics, regulators, and bankers gathered in Boston on July 9 for the Federal Reserve stress tests conference, which scrutinized stress tests’ transparency and effectiveness. He framed the central question for policymakers as:
Do stress tests serve their purpose in protecting the public, taxpayers, the financial system, and our economy from undercapitalized, over-leveraged, too-big-to-fail banks that pocket profits and bonuses in good times, and shift their losses to taxpayers and Main St. in a crisis?
Kelleher spoke on the conference’s first panel, which discussed “Stress Tests as a Policy Tool.” Not being a banker, a regulator or academic, Kelleher, in his role as an advocate for the public interest, began by reminding the audience of what is at stake when talking about financial reform and stress tests:
“The only thing standing between a failing bank, a taxpayer bailout and an economic and human catastrophe is loss absorbing capital. Period. Full stop. That is really what we are talking about when we are talking about stress tests.”
He then made several key observations. First, he said that “stress tests” should be viewed as “credibility tests” for the Fed, which, he said, should not snatch defeat from the jaws of victory by weakening stress tests given how well they have worked. In fact, the US stress tests are the gold standard and have been copied around the world.
He also questioned the “peacetime/wartime” framework used by some to justify weakening the rules by pointing out that everyone – including notably the Fed – was wrong last time and failed to see the 2008 crash coming. That proves beyond doubt that no one can reliably predict when it is peacetime (no crash coming) or wartime (crash happening). Moreover, he noted, some of the rules to protect Main Street taxpayers haven’t even been completed and none have gone through an entire business cycle. Therefore, workers, homeowners, students, retirees, taxpayers and, really, everyone on Main Street remain at risk of having to bail out Wall Street again. Put differently, it is way too early to start weakening the protections that have not been tested in a downturn.
He also called out the cozy culture of influence between regulators and bankers. Kelleher said that “policymakers in general and regulators in particular should accept that conflict in financial regulation is inevitable, healthy and, indeed, a sign of success.” Disagreement and tension should be ever-present in that relationship as banks seek to profit maximize and regulators seek to reduce their anti-social, high-risk and dangerous activities where banks profitably externalize their costs.
Kelleher pointed out, however, that evil actors in – or evil motives by – the private sector are not required for any of these observations or concerns:
“It is the nature of markets and financial firms, individually and, ultimately, collectively. It’s the siren songs of profit maximization and competitive pressures.”
To drive home this point, Kelleher quoted Upton Sinclair: “It’s difficult to get a man to understand something when his salary depends on his not understanding it.” Knowing laughter rippled through the auditorium.
He concluded by emphasizing that any analysis of “stress tests as a policy tool” (the title of the conference) must put the protection of the public, taxpayers, the financial system and the economy as the number one priority. Some suggested focusing on the needs of bankers and regulators. Kelleher rejected that unequivocally.
The video of the conference is available here and Kelleher’s panel begins 30:07. We will be providing more commentary on the conference and stress tests in upcoming Better Markets newsletters, blog posts, and media appearances.
In the meantime, this collection of commentary, analyses and other resources can help you make sense of the issues and view some of our prior work on stress tests over the years:
Better Markets was pleased to be invited to speak at this critically important conference and to engage with many of the participants, from Vice Chairman Quarles and Governor Brainard, to many distinguished academics and senior representatives of industry.
We were able to do this thanks to your support. Together, we are speaking up for Americans whose jobs, homes and savings are protected by stress tests!