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May 3, 2018

Chipping Away at the Most Successful Pillars of Financial Reform, Key Regulators Discuss More Banking Deregulation is On the Way

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Fed Vice Chairman for Supervision Randy Quarles in testimony before the House Financial Services Committee and the Senate Banking Committee made it clear that the pace of deregulation will be increasing at the key financial regulatory agencies. The previous week, the Fed had released proposals on the Supplementary Leverage Ratio (SLR) and the Comprehensive Capital Analysis and Review (CCAR).

In addition, Mr. Quarles testified that he wants to consider opening up the stress tests scenarios to public comment. This is something that banking lobbyists had long, though unsuccessfully, sought during the Obama administration as such a change could potentially give banks more influence over the parameters of the exams. Such a move could give the banks a roadmap to passing the stress tests, rendering them much less useful.

It is undeniable that stress tests are one of the most important and successful elements of post-crash reforms that were incorporated into the Dodd-Frank law. No less an authority than Gary Cohn — when he was President of Goldman Sachs — sang the praises of stress testing, which was a critical tool used to restore confidence in the U.S. financial system at its most perilous time and since then. The Fed has built up an enormous amount of credibility worldwide with the effectiveness of its stress tests and it should not put that at risk to satisfy what will be a passing, but very dangerous deregulatory zeal.

At those same hearings, Mr. Quarles also described the Volcker Rule as “detrimental” to capital markets and said the Fed is working with four other Federal agencies to revise it. He also said that it was “unarguable” that the Volcker Rule has negatively impacted market liquidity. We, however, are unaware of any independent, robust data supporting that view. Indeed, of the many studies that have been done, including by the SEC, Treasury and the Fed, no evidence has been found that the Volcker Rule has damaged liquidity.

Stephen_F._Lynch.jpgBetter Markets echoes what others, including FDIC Vice Chair Thomas Hoenig, have said recently that carving up the Volcker Rule is a mistake. This sentiment was captured quite well during the hearing when Rep. Stephen Lynch (D-MA) commented that he was worried about streamlining the Volcker Rule,

“No is no. There is no streamlining. We wanted it [high risk, dangerous, capital depleting propriety trading by taxpayer backed banks] to stop, and it has stopped.”

That’s the success of the Volcker Rule. While some say proprietary trading had nothing to do with the financial crash, they need look no further than Morgan Stanley, which, in December of 2007, had to write off a $9 billion proprietary bet loss at the same time that it had to take massive write downs due to its subprime lending and derivatives activities. Just nine months later and just five days after Lehman Brothers failed, Morgan Stanley had burnt through all its capital and informed the Fed that it was going to fail unless it was rescued by the government, which then bailed out Morgan Stanley and Goldman Sachs.

Banks love to “prop trade” because it’s like going to Vegas with someone else’s credit card: using other people’s money, it costs little to do; it allows them to pocket gigantic bonuses; and, best of all, shift their losses to someone else like taxpayers. That’s why, as Congressman Lynch said, “we wanted it to stop” and why it should remain stopped.



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