Less Stress Sometimes is a Bad Thing
Will altering the frequency of big bank stress tests from annual to every other year leave the big banks less prepared for a future financial crisis?  That is the question addressed in comment letters filed by Better Markets with the Federal Reserve and FDIC regarding their recent proposals implementing the deregulation law referred to as “S. 2155.”  For the most part, the proposals were relatively straightforward implementations of law, but one aspect of the proposals was unnecessary and unwise – S. 2155 requires that companies conduct “periodic” stress tests, and the agencies are proposing to reduce the frequency of company-run stress tests from annual to every other year.

Of course, reducing the frequency of stress tests is not required by any language in S. 2155.  As we point out in our comment letter, an annual stress test is every bit as “periodic” as biennial stress test.  More importantly, however, this seemingly small change could have big impacts down the road, because stress testing is an incredibly important aspect of the current regulatory framework. 

The tests serve multiple functions.  During normal economic periods, they serve to provide regulators and the firms themselves with crucial information about their ability to withstand stress.  And during periods of economic distress they can reassure markets that large banks will not only be able to survive the period of stress, but will be able to continuing performing their key functions.  To perform those functions, however, stress tests need to be credible.  And reducing the frequency of company-run stress testing to every other year threatens to undermine their credibility – during a period of economic stress, conditions can change quickly, and markets may not view tests conducted nearly two years earlier as a reliable indicator of a firm’s present health.   

Ultimately, when considered with other deregulatory proposals that would reduce capital and liquidity requirements, this change could potentially increase the risk and severity of another crisis. The Federal Reserve and FDIC should carefully consider the consequences of decreasing the frequency of company-run stress tests.

Thanks to Trump Tax Cuts Big Banks Make Out Like Bandits, Leave Main Street Pockets Empty
The big banks have reaped tens of billions of dollars thanks to the Trump tax cuts according to the fourth quarter report on bank performance by the Federal Deposit Insurance Corporation (FDIC). Banks garnered an astounding $28.8 billion in additional income, more than a third of their previous year’s income.

This comes as reports continue to show that American taxpayers are receiving smaller tax refunds than in the past.

The report led President and CEO of Better Markets to make the following comments to Politico:

A large chunk of their profits “were from the Trump tax cuts, which they didn’t pass along to tens of millions of hardworking Americans, who are still getting next to nothing on their savings accounts,” he added.

Additionally, the FDIC report showed that the other main source of bank income was as a result of the Fed’s recent interest rate increases.  The combination of tax cuts and what’s called “Net Interest Margin” or the difference between the interest rate banks charge for loans (which is based on the Federal Reserve interest rate) and the interest rate the banks are paying out to customers with savings accounts, are how the big banks were able to pocket over $100 billion in profits for the first time ever.

On that part of the FDIC report and in the same Politico article, Dennis Kelleher said:

“The bigger banks only exist because they were bailed out, supposedly because they provide a social benefit, but here we are 10 years later, and we’re still waiting to see the benefit,” said Dennis Kelleher, president and CEO of Better Markets, which advocates for tougher financial regulation.

Paul Volcker: Banks’ Focus on Profits Shows Misplaced Priorities
When former Fed Chair Paul Volcker talks, people listen.  Or at least they ought to listen, as there are few public servants whose experience in both time and breadth can compare to Mr. Volcker. 

In his recent interview with industry analyst Mike Mayo and the CFA Institute, Mr. Volcker’s insights and observations proved Mr. Mayo’s description of him correct:  he serves as

“a reminder of our collective duty as finance professionals to ensure that the financial economy is connected to the real economy.”

The banks, Mr. Volcker said, have misplaced their priorities with a focus on profits, a problem he says is largely attributable to incentive pay:

“You now have this situation with incentive pay dominating corporate and individual decision making. If the top executives are not getting as much pay as their competitors, the directors will worry about it and feel impelled to match the competition to show that they value your work. [It] has gotten all out of context, it seems to me. The amount of pay involved in the banks themselves is worrisome…”

Farther along in the interview, Volcker commented that, “The Holy Grail has been that the only thing that matters is how much profit the firm (and you) make…This is deeply in the interest of the people running these banks.”

Nonbanks also figured prominently in Messrs. Mayo and Volcker’s discussion, and are another source of concern, as Volcker commented:

“The non-banks have gotten much bigger relatively, and they don’t have the same regulatory framework. They have a lot more scope. The entire market is so much more complex, it is hard to follow.”

And, of course, they discussed the Volcker Rule, named for the man himself, prohibiting proprietary trading, and the relentless complaint from banks that it is too complicated and too complex.  On that, Volcker said that it is actually quite simple:

“Are you operating for yourself, or are you operating for a customer?

“I heard complaints from banks: ’We know our customers want to buy securities. So we stock up on securities knowing that they will buy them later.’ To them it is heroic trading. To me it sounds like front running.”

Everyone should reflect on the state of finance and think about Mr. Volcker’s perspective.