Editorial – Bloomberg Opinion: Biden Faces Crucial Choice in Financial Reform | Editorials

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This editorial appeared in Bloomberg Opinion on September 14:

NEW YORK – Federal Reserve Chairman Jerome Powell has done a great job managing the U.S. economy both through the vagaries of the Trump administration and the ongoing coronavirus pandemic. Yet the Fed under his leadership failed in one crucial area: ensuring the long-term health and resilience of the country’s financial system.

President Joe Biden has the opportunity to remedy this shortcoming. He should use it.

Given how the financial system appears to have weathered the pandemic, one could be forgiven for concluding that everything is in order. It’s not.

Banks have avoided debilitating losses in large part because the Fed and the Treasury have pledged trillions of dollars to stabilize markets and help borrowers repay their loans. It was the correct answer, but it also obscured some lingering weaknesses.

Consider a crucial indicator of financial strength: equity. Unlike forms of debt such as deposits, capital represents funds from investors willing to share the risk of losses. When banks have plenty of them, they are better able to operate in a crisis and help with the Fed’s recession-fighting efforts. But to achieve this, it takes persistence: bank executives generally prefer to resort to more debt or leverage, which benefits from government subsidies and increases certain measures of profitability in good times.

The authorities were successful in raising more capital in the aftermath of the 2008 financial crisis, but never went far enough. At the four largest U.S. banks, tangible equity peaked at around 8% of tangible assets at the end of 2015, far less than research from the Minneapolis Fed and others suggests would be needed to reduce risk. failure to an acceptable level. Since then, capital levels have declined with political will: in June 2021, this tangible capital ratio stood at around 6.4%.

The Fed played a leading role in the fraying. Randal Quarles, the vice president of banking supervision appointed by Trump, asserted in 2019 that “the capital formation phase of the post-crisis era is now over”, citing as evidence the ability of banks to resist to hypothetical recessions and market collapses during annual strains. testing. Yet those tests failed to capture the severity of a real crisis – and under Quarles, the Fed made them even less stressful, allowing banks to return large amounts of capital to shareholders in the form of dividends and cash. share buybacks.

Under the rubric of greater simplicity, the Fed has also weakened supervision in other ways. He turned an initially sensible reform into an ouster of the Volcker rule, intended to curb speculation in financial institutions that benefit from government safety nets. All of this put an end to the old annual “living wills,” aimed at streamlining corporate structures by challenging banks to explain how, if they failed, authorities could quickly dismantle them with minimal collateral damage.

Now, for larger institutions, full plans are only required once every four years. Imagine trying to shut down Lehman Brothers in 2008 using instructions written in 2004.

The Fed is right about one thing: supervision can and should be simpler. The way to do this, however, is first to insist that banks accumulate enough capital to absorb the losses that real crises have historically generated and have yet to spare.

If banks were stronger, restrictive practices such as regular stress testing and micromanagement by reviewers would be unnecessary. And if regulators imposed more stringent and effective limits on taxpayer-supported activities, hundreds of additional pages of rules could be removed.

This is where Biden comes in. The Fed needs a bank supervisor who is willing and able to pursue the twin goals of strength and simplicity.

Quarles’ four-year term ends in October. With the right appointment, the president can send Powell an unequivocal signal – and set a much more promising path for financial reform.

Editorials are written by the editorial board of Bloomberg Opinion. © 2021 Bloomberg Notice.

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