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Yale Journal of Financial Crises A Conversation with Paul A. Volcker

Yale Journal of Financial Crises A Conversation with Paul A. Volcker

July 20, 2020
[It is no secret that Paul Volcker was and remains a hero to me.  Paul died in December 2019 at the age of 92, so the interview below with Yale University might be the last in-depth interview with a great American (and citizen of the world).  The interview is extensive, and I’m not sure how Paul was able to pull it off as he was struggling from the effects of cancer.  Paul and I had disagreements when he and I dealt with the banking and thrift crises that ran from 1978 through 1992 during which some 3,000 banks and thrifts failed and thousands more were severely weakened.  The Great Depression was a more difficult period but it did not have nearly as many very large banks in serious trouble. And it is possible our current economic struggles resulting from Covid-19 might in the end be more difficult, but I pray not.  I am very thankful that our nation had a Paul Volcker when he was really needed.  And I am honored to have served at his side.]

Yale Program on Financial Stability Lessons Learned

A Conversation with Paul A. Volcker
By Andrew Metrick, Rosalind Z. Wiggins and Kaleb Nygaard

On March 26, 2019, Andrew Metrick, the Janet Yellen Professor of Finance at the Yale School of Management and Founder and Director of the Yale Program on Financial Stability1 sat down with Paul A. Volcker to discuss his perspectives on the Federal Reserve, central banking autonomy, “too big to fail,” and how his perspectives on these topics have changed over the decades. It turned out to be one of the last interviews given by the former Chairman of the Federal Reserve System who passed away on December 8, 2019, at the age of 92.

An Esteemed Legacy
During the 2007-09 financial crisis, the government’s interventions to shore up the collapsing financial system were unprecedented as to scale and quantity. Support to specific entities was often discussed as being made on the basis that the entity was “too-big-to-fail,” a term first coined in 1984 when the government intervened to save Continental Illinois National Bank and Trust Company, a large national bank that was about to fail. It would have been the largest bank failure in U.S. history at the time and would have remained the largest until the 2007-09 crisis. The Federal Reserve coordinated with the FDIC to save Continental, the rescue of which gave rise to the term “too-big-to-fail.”

Paul A. Volcker was Chairman of the Board of Governors of the Federal Reserve System during the administrations of Presidents Jimmy Carter and Ronald Reagan from August 1979 to August 1987. In 1984, he was instrumental in the decisions and actions taken to save Continental Illinois. Previously, Volcker had also, from August 1975, served as President of the Federal Reserve Bank of New York, where he was actively involved with monetary policy decision-making processes and became a proponent of monetary restraint. He also served as an economist with the Federal Reserve from 1952 to 1957 when he left to work in the private sector.

Volcker was the proponent of the namesake, Volcker Rule (adopted in 2010 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act), which limits proprietary trading by banks. Volcker was appointed by President Barack Obama as the chair of the President’s Economic Recovery Advisory Board on February 6, 2009. He also was the founder of the Volcker Alliance whose mission is “to advance effective management of government to achieve results that matter to citizens.”

Continental Illinois and Too-Big-To-Fail
Metrick: Today we were hoping to talk to you about topics that we focus on at the Yale Program on Financial Stability where we study crisis fighting. Of all of the many things that you worked on, the decisions around Continental Illinois [National Bank and Trust Company] were really important at the time and important for the future. It only received five pages in the Silber Volcker book but I detect in reading your book7 that you’re happy about some parts of it and unhappy about other parts of it. There are hints in the book that you wish you had objected more to certain things or done some things a little bit differently.

Volcker: There are a number of lessons to be drawn from that scenario. You know from the book or otherwise that at that time, the penchant of the Federal Reserve, or any other regulator, for effective regulation was not very great. At one point I think they had been worried about capital positions, but that had all died away. By the time that I becameChairman [in 1979] there weren’t any capital requirements that meant anything.

We knew that Continental Illinois was in trouble after learning about a bank in Oklahoma, Penn Square Bank, that was having trouble. The Oklahoma bank had made all these oil loans and then pitched them off to Continental Illinois and another bank, Seattle First.

In the summer of 1982 Roger Anderson, the chairman of Continental Illinois, visited me on a fishing trip and told me they were going bust. At some point we said we were ready to lend them quite a lot of money.

We kept an eye on it, but I didn’t think that Anderson was doing enough to fix their problemand I said as much to the lead director, but he deferred to Anderson. I remember that was typical of the kind of strength of banking regulation and of the seriousness of which directors and so forth took supervision.

The Oklahoma bank, Penn Square Bank, had preceded this by about a year. We finally let that go, but they had almost no uninsured deposits, so there wasn’t much [good business] about it except that one of the big depositors was a credit union of the U.S. Congress.

We had had this earlier situation with another bank, First Pennsylvania, right after I became Chairman. It was an interesting case because that was the first big failure. They had bought a load of long-term Treasuries and then they went sour. They had so many of them that it jeopardized the whole bank. In the end we arranged a rescue where, as a formality, some of the private banks put some money in with us so it looked like a private rescue.

That was the plan that I had in mind with Continental, which was a much bigger fish. So, we put the proposition to FDIC Chairman, William Isaac.

We were together on this. The FDIC put in a little capital and we asked the banks to put some more capital, and we would provide all the liquidity it needed. Well, the banks weren’t in the mood to put any more capital in.

So, we had to go ahead anyway. And I was unhappy about it at the time, I thought Isaac was probably right. I had to go get an honorary degree that day at Columbia, and if I didn’t showup….

Metrick: They would know something was wrong with Continental Illinois.

Volcker: Right. So, we left it to Isaac to arrange it all. And when I got back it was basically all arranged with one difference, he was going to guarantee all the deposits.

Metrick: Even the uninsured ones.

Volcker: Yeah, which, as a matter of policy I didn’t want to do. I thought if the FDIC put in some more capital, the Federal Reserve would pledge to provide all of the liquidity and so forth, and things would straighten out without formally guaranteeing the deposits. But Isaac wanted to be sure, and he may have been right. He thought he was protecting the FDIC by going all the way.

I don’t remember any debate about this, but the way he put in the capital included protection for the subordinated debt of the holding company as well. We didn’t want to do that, but that was Issac’s decision. So, the bank stumbled along and eventually got sold to some company and then it disappeared.

On the Role of Financial Supervision
Metrick: You hinted about the role of Fed supervision during the time of Continental Illinois as being very different from its monetary policy function. Care to elaborate?

Volcker: Continental Illinois was an example of a lack of effective supervision that existed back in 1984. It was all an illustration of what the matter with the regulatory system was. You had three regulators for the bank (the Fed, the FDIC, and the OCC was the third because it was a national bank) and certainly Continental looked at the Fed as the principal supervisor as they should have. At the time, I also thought that we were the premier agency in terms of supervision. But we were not doing a good job, nobody was.

I never read the book, The Secrets of the Temple, because I knew it was anti-Federal Reserve, but it’s actually a very knowledgeable book. So, in this book the author interviewed Chuck [J Charles] Partee, who was head of the Federal Reserve staff for many years. He was put on the Board, which is a precedent in itself.

The author of the book interviewed him, and the author says that he thought we were very efficient in dealing with inflation, but he said, “Even if I grant your case that inflation was an enemy and you had to deal with it, you could have dealt with it more effectively if you used your supervisory tools instead of putting us all in a recession. Why didn’t you do that?” It’s a good question.

You are politically exposed, particularly when you’re tightening up. But by and large, at the end of the day people know you’re responsible for monetary policy and they don’t really lobby you that much.

In supervision, they lobby the hell out of you. And all the lobbying money goes into supervision and you don’t want to take on two enemies at the same time.

The supervised is never happy, and the supervisor is never happy, and it’s just as true today. This continues to be a big problem today. How do you effectively supervise these institutions?

It’s just very hard to get a Federal Reserve Bank to toughen up its supervision. I think it’s probably better now than when I was first there. The Presidents of the Federal Reserve banks weren’t so noisy as they are now on policy and so forth.

The Presidents have a dilemma. They want to be an established member in the business community in Kansas City. They want to be friendly; they want to be on the Chamber of Commerce. And you don’t get to be a respected figure in Kansas City if you’re attacking, or seen to be attacking, the local banks in Kansas City.

It’s not a comfortable place to be, but the Reserve Banks can hide behind the Board regarding the supervisory responsibilities.

Metrick: And not be so tough on their own banks?

Volcker: Right. But, once in a while you get a tough regulator. Dan Tarullo—now he was the toughest supervisor I think the Federal Reserve had. Dan Tarullo was very experienced, very knowledgeable. And Tarullo wasn’t brought up in the banking world; he was a lawyer.

Metrick: But you think he did a good job?

Volcker: I think he made a difference, he made it more consistent and toughened it up and so forth.

I love to describe this experience Janet Yellen had when she was being quizzed by this government report about supervision when she was the president of the San Francisco Federal Reserve Bank. The conversation, not quoting directly, went something like this. Theysaid, “We understand Mrs. Yellen, that you’re one of the people who called attention to thedeteriorating mortgage market and subprime loans.”

She said, “Thank you for mentioning it; that’s true.”

Next question, “Why didn’t you do something about it?”

Yellen says, “Well, it wasn’t the responsibility of the San Francisco Fed. It was up to the Board. We mentioned it to Mr. Greenspan, but they weren’t much interested, and it wasn’t really our business anyway, so I didn’t get aggressive and the Board was not aggressive.”

It was a good question, and the Partee answer [splitting-off the regulatory role from the Federal Reserve] was compelling. I strongly believe that the Federal Reserve ought to be the principal regulator, but when you listen to Partee’s answer you begin wondering whetherwe ought to have a special regulator. But the British tried that.

Metrick: And it didn’t work.

Volcker: They fell completely on their face because that independent, special regulator was more overwhelmed by lobbying than the Federal Reserve would be.

But how do you deal with this problem? You have it today. It’s not going to go away, so what do you do? That’s what you’re struggling with still.

Deciding Between Non-Ideal Choices
Metrick: Yes, that’s what we’re struggling with. So, what I think I’m hearing you say is that in the Continental Illinois case, because of how weak regulation was going into it, the situation just had no good choices. And ultimately, you’re not happy with the fact that some too-big-to-fail beliefs got created by what happened, but at the same time you don’t have a specifically different path that you think would have worked better.

Volcker: No, I don’t. The thing I disagreed with was, I wanted to put so much firepower behind it, but I didn’t want to guarantee everything. But it didn’t make much difference. If we had not guaranteed everything, I think the same thing would have happened.

Metrick: So, if you had done the alternative strategy of, “we’re not going to make this statement about guaranteeing everything, but the Federal Reserve is going to lend, lend, lend…” It wasn’t the statement that created the belief, it was the firepower.

Volcker: Isaac’s issue was, “Okay we, the FDIC, don’t guarantee everything. You, the Fed, are going to put in all this liquidity. But if it goes bad, we’ve [the FDIC] got to pick up all the mess, and the Federal Reserve will go home with all the collateral.” And he was absolutely right. If it had happened that way, he would have been right.

And he said, “That’s not going to happen.”

Metrick: It sounds like, with regards to the FDIC’s specific decisions, you would have done things a little bit differently, but you think it would have engendered basically the same result in the market.

Volcker: I don’t know. Suppose in the original plan the banks had put in a billion or so and the FDIC had put in two billion.

The Federal Reserve would have put in the liquidity. There was some discussion of this scenario, but the banks turned it down. Whether the appearances of that would have modified the too-big-to-fail rhetoric, I don’t know. The stockholders did fail.

Metrick: Yes, and that’s an important distinction, the same thing happened in the recent crisis. Stockholders often got hit badly. But the big alternative would be to have let them go. And your view was that that would have led to real panic.

Volcker: Continental was a big correspondent bank in the Midwest, so it probably had 400 little Western, Midwestern banks that had a big investment in it, and it had those big oil loans, which would have been exposed, which eventually were exposed anyway. That exposure killed First Seattle Bank. Chase Bank had a lot also. I don’t know what would have happened to Chase if Continental Illinois had failed. Chances were very high that you would have had a run on some of the other banks and you certainly would have had runs on some of the smallbanks. You can say, “So what? They’re mostly FDIC insured and so forth…” But it sure would have shook up the system. How much it would have shaken up the system, I don’t know.

Metrick: Enough that you didn’t want to risk it.

Volcker: That’s for sure. Not on my watch.

The Federal Reserve as Regulator was Different Then
Metrick: Now you had talked a little bit I think in one of the events that you came into at Yale about how you had gone out to Chicago earlier to try to get Continental Illinois to get their act together. Can you reflect on that?

Volcker: Actually, it was just a routine visit. Right after I became the new Chairman of the Federal Reserve, I was visiting the Chicago Reserve Bank.

While I was out there, I looked at the position of First Chicago and Continental, and I said I want to talk to those guys. I had both the Chairman and a Director in the room. I said, “Look here, you’re undercapitalized, you got to get your capital up.” Here I was, brand new Chairman of the Federal Reserve. I was going to be the boss, “You got to get your capital up.”

And they basically said, “You have no authority over our capital.” Which at the time was a debatable point, whether we could have used our general supervisory authority. But theytold me, “You don’t have any authority over our capital.”

If you went back ten years earlier the Fed did have a formula for capital, but nobody followed it and they finally dropped it.

So, I say “We’re going to get you guys supervised.” And that got me off on this capital business. But I admit being a little shocked at the rude treatment as the new Chair of the Federal Reserve.

I’ll tell you another similar story. Years earlier, when I was the brand-new President of the Federal Reserve Bank of New York, I’m sitting in my little office and the First Vice Presidentcomes in and sees me and he says, “Tomorrow we have our annual lunch with Citibank.”

“Having lunch? What’re we having lunch for?” I ask.

“We get together and discuss what’s going on in the market and what problems they foresee.” “Do you use this to get them in shape, with capital?”

“No, no, this is just chatting about good customer relationship.”

So, I say, “Let me see their goddamn balances.”

He gives me the balance sheet. And I look at it and I don’t understand it. I’m thinking he gave me the wrong bank. It says National Citi, but I don’t recognize any of the figures. “What’sgoing on here?”

He said, “Oh, that’s just the domestic bank, that’s all we look at.”

And at that point Citibank was probably as big as its domestic bank, but they didn’t look atthat. “Who looks at that?” I asked.

“The Comptroller looks at that.”

“Do you ever consult?”

“No.”

This is the famous time when they came around and told me quite seriously, “Citibank didn’tneed any capital. Why do we need any capital? We gain profit every year.”

They actually had a memorandum supporting this theory. They believed it.

Metrick: If we make money every year, why would we need any capital? There’s no risk that we won’t make money.

Volcker: Exactly.

Metrick: So, if you look now at the decisions that were made in 1984 around Continental Illinois, and you were advising yourself—so Paul Volcker 2019 is advising Fed Chairman Paul Volcker 1984 (who was still a little green at the job)—would you recommend anything differently? Other than not getting the honorary degree from Columbia, so that you would be there for everything. Was there anything you think you would do differently having seen what then happened 35 years later?

Volcker: Well I’m sorry that we didn’t guarantee the nonbank holding company. They had maybe $400 million or something of obligations to the holding company that they wereselling as the crisis unfolded. The bondholders, they were selling…They had bought back halfof those ventures, bonds, whatever they had. I discovered that just a few days before and Isaid, “Stop it, you can’t…”

Metrick: Buying them back at discount.

Volcker: Yeah, you’re not going to buy your liabilities back with Federal Reserve monies. It’s ridiculous. So that’s why there was still a couple hundred million leftover, which they got guaranteed. It was a little messy.

The Status of “Too-Big-To-Fail” Today
Metrick: Although Continental Illinois happened in 1984, “too-big-to-fail” played asignificant part in the 2008-09 crisis. What’s your assessment of where we stand todayon this issue of “too-big-to- fail,” after all the legislation that you were part of, where doyou think this stands?

Volcker: Well I would like to think, maybe overoptimistically, that with enough cooperation in London and elsewhere, you could try out the authorities that the FDIC has, Title II, the Orderly Liquidation Authority.

People know that it’s there. It deals with the stockholder problem. It permits an effective bailout of the debt holders and effectively kills the stockholders. I think politically that’ssellable. I see that it could work.

Metrick: What you said around the time of Continental Illinois I think is still an issue today, which was something along the lines of, “We could probably handle one $40 billion bank going down, but if it’s multiple $40 billion banks, it’s going to be a real problem.” I think the sense that a lot of people have about the Orderly Liquidation Authority is that it could maybe work in an idiosyncratic special case, but in a real systemic crisis we would need something else.

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BankThink Repealing brokered deposit law would be a costly mistake by Richard M. Kovacevich published by American Banker

BankThink Repealing brokered deposit law would be a costly mistake by Richard M. Kovacevich published by American Banker

July 6, 2020

Those of us who went through the savings and loan crisis and the rash of bank failures in the 1980s remember the devastating effect brokered deposits had in causing and driving up the cost of those collapses.

Despite the urging of the Federal Deposit Insurance Corp.’s then-Chairman Bill Isaac, Congress only addressed the issue after the fact, restricting brokered deposits through a new section of the Federal Deposit Insurance Act.

Since then, the FDIC has repeatedly studied brokered deposits, concluding that it is, in fact, correlated with a higher rate of bank failures as well as an increased cost of resolutions. That’s why it is disheartening to see the bank trade associations and even the FDIC now considering a repeal of that restriction in the FDI Act — the only law dealing directly with brokered deposits. Legislation was recently introduced in Congress to implement such a repeal.

While there have been significant changes in how banks gather deposits, the basic problems caused by brokered deposits remain. In 2011, Congress mandated that the FDIC published an extensive study on the issue, finding that as “brokered deposit levels increase, the probability that a bank will fail also increases.” Furthermore, the study also found that banks with higher levels of brokered deposits were also more costly the Deposit Insurance Fund in the event of failure.

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Letter to the Treasury Secretary from four bi-partisan Senators

Letter to the Treasury Secretary from four bi-partisan Senators

June 8, 2020

[We have added a new item to my website — a letter from four bi-partisan Senators urging Treasury Secretary Munuchin to delay implementation of the accounting convention, Current Expected Credit Losses (CECL), adopted by the Financial Accounting Standards Board (FASB), a self-anointed board without routine oversight or control by government agencies. Secretary Munuchin, as Chairman of the Financial System Oversight Committee, is authorized by the Dodd-Frank legislation to review and challenge any law that might substantially and negatively impact the economy and the financial system.

FDIC Chairman Jelena McWilliams recently expressed her concerns about the negative impact CECL is likely to have on the banking system and the economy. For example, CECL required the 200 largest banks to increase their reserves by 60% during the first quarter of 2020 compared to the first quarter of 2019, representing tens, if not hundreds of billions of capital taken out of the banking system’s capital and reducing lending capacity by eight to ten times the capital reduction — all as we might be moving into a treacherous time in the economy and banking system.]

Dear Secretary Mnuchin: 

As the nation grapples with the Covid-19 pandemic and the resulting unprecedented public health and economic crisis, appropriate planning must be made for the future and that incentives are aligned for the country to rebuild. However, we are concerned that the decision by the Financial Standards Accounting Board (FASB) to implement the new current expected credit loss (CECL) accounting standard on January 1, 2020, for mid-size, regional and national banks, credit unions, and other financial services firms will make it harder for consumers and businesses to access credit. We request that the Financial Stability Oversight Council (FSOC) conduct a study on the new standard’s impact on lending and economic consequences overall. 

Even prior to the current economic downturn, there was an insufficient understanding of the potential economic impacts of the new accounting approach on banks and the customers and communities that they serve. As banks, credit unions, and other financial services firms built new models and operational systems to adopt the CECL standard, concerns grew that it would impact their ability to lend. Worse, those affects would be pro-cyclical during an economic downturn and slow a recovery. During this debate, it was unimaginable that we would face a global pandemic leaving a devastated economy in its wake. Unfortunately, this is where we now find ourselves. 

In March 2020, Federal Deposit Insurance Corporation (FDIC) Chairman Jelena McWilliams wrote to the FASB expressing concern that the COVID-19 pandemic had caused “sudden and significant changes in the economy,” noted the “uncertainty of future economic forecasts,” and contended that the economic crisis made the sophisticated models designed to account on the day a banks books a loan for all future credit losses, as required by CECL, “potentially more speculative and less reliable at this time.”1 

The new standard’s impact can be seen on the dramatic increase on the loan-loss reserve levels of banks of all sizes. The reserves for the 200 largest banks, which have community, state, regional, and national footprints, increased by nearly 60% at the end of the first quarter compared to the quarter ending 2019, representing billions of dollars of capital that has been taken out of the system during a moment when it is most needed.2 

While it is possible to disagree about the wisdom of the timing of the CECL adoption during the pandemic, now is the optimal time to assess CECL’s economic impact, including how the policy affects products and lending decisions of financial institutions, and especially the consequences on customers in low-to-moderate income communities. For that reason, we believe FSOC should begin a comprehensive economic impact study about the economic consequences of the CECL policy over the next four quarters. 

Instead of relying on speculation and models, that look backward as much as forward, the FSOC can gather current macroeconomic data and banking metrics. The FSOC can observe a year’s worth of data and complete a report by July 2021. We look forward to its findings and expect it to better inform the debate around CECL and its impact on lending to consumers and businesses by financial institutions and financial services firms. 

Sincerely, 

Doug Jones
United States Senator

Thom Tillis
United States Senator 

Jon Tester 
United States Senator

Kevin Cramer
United States Senator 

 

1 FDIC Chairman McWilliams letter to FASB, “FDIC Chairman Urges FASB to Delay Certain Accounting Rules Amid Pandemic,” March 19, 2020. Available at: https://www.fdic.gov/news/news/press/2020/pr20036.html

2 Morgan Stanley report on 1Q 2020 Bank Earnings Update, April 2020.

Embracing Facts Over Fear: Coronavirus In Life Years by Edward J. Pinto

Embracing Facts Over Fear: Coronavirus In Life Years by Edward J. Pinto

May 20, 2020

“As of May 17, about 91,000 lives have been lost to the coronavirus. Notably, those aged 65 or older accounted for 80 percent of these deaths and residents or employees of long-term care facilities accounted for one third of all deaths. Based on life-expectancy and taking into account that 90 percent of all coronavirus deaths had one or more co-morbidity factors, an estimated 800,000 life-years have been lost.

This is about half the number of life-years lost to the 38,000 motor vehicle driver fatalities in 2018. The reason for this disparity is simple. The median age of coronavirus fatalities is 81, while the median age of driver fatalities is about 40 years.

To put it in an even clearer prospective, someone aged 45-54 has the same likelihood of dying in motor vehicular accident in one year as from the current coronavirus pandemic. And someone aged 35-44 is about one quarter as likely to die in such an accident as from the coronavirus pandemic.

It would take a doubling of deaths due to coronavirus to equal the driver life-years lost in 2018 due to vehicular deaths.

What does this mean from a policy perspective?

First, stop the multi-trillion dollar bailouts. Quit shutting down large swaths of the economy and paying people not to work. Instead, aggressively reopen the economy in those states and counties that have warmer temperatures, low case and death rates per capita, declining case levels, and minimal mass transit. And of course, we should implement best health practices and protect those living or working in nursing homes, food processing facilities, and prisons.

Second, in places historically reliant on mass transit, focus on removing the friction that prevents employees from returning to work. Consider providing a business’s employees and self-employed individuals a tax credit of up to $1000/month for 3 months to be used to pay for parking, ride-sharing and taxis, rental cars, tolls, and gasoline. And, there is a large surplus capacity for each of these today. This would also help take demand pressure off of mass transit operators. The cost would be $30 billion for say 10 million currently unemployed individuals.

Third, places like California are mired in shut down orders and slow re-openings. According to data from Safegraph, San Francisco’s level of foot traffic has recovered to only 42 percent since its low of 33 percent in mid-April. Los Angeles is in a similar situation. Compare this to Dallas, where foot traffic is at 66 percent, up from 42 percent in mid-April. Atlanta and Houston have posted similar gains. Why is this happening, given that California is 33rd and 29th lowest respectively in cases and deaths per capita?

Fourth, get the facts straight about so-called spurts in cases and deaths. A May 14 headline about Texas blared: State reports largest daily increases in cases and deaths. Ignored was that Texas, the second largest state, is 39th and 40th lowest respectively in cases and deaths per capita. Also ignored was the fact that more than 16K prisoners and staff had been checked for COVID-19 in first 3 days of self-testing. Or that, thousands of Texas nursing home residents have tested positive for coronavirus.

Fifth, accelerate access to so-called elective medical treatments. According to foot-traffic data from Safegraph, hospitals are only at about 60 percent of normal activity. Elective surgery only means you get to choose a date, not that it isn’t potentially life-threatening.

Americans want to go back to work. It is time to let them again exercise their rights to life, liberty, and the pursuit of happiness.”

A Former FDIC Chair Walks Into a Bank

A Former FDIC Chair Walks Into a Bank

May 16, 2020

It sounds like the start of a joke.

William Isaac, the chairman of the Federal Deposit Insurance Corp. during the savings and loan crisis of the 1980s, walks into a bank. It’s mid-March, and he wants cash.

He doesn’t take out a “massive amount” but “enough to get by for a month or so, if there was some problem or some issue in the economy, and the banks were not available.”

The former chairman of the insurance fund — who oversaw the closure of more than 1,000 institutions, including the first “too big to fail” bank — felt the need to withdraw cash as states began shutting down to slow the spread of the coronavirus.

That’s the joke.

“I wasn’t concerned about the banks; I know they’re safe, and what I took out was not nearly as much as I left in,” he says. “I just felt that stores may close, and banks may [reduce their] hours, and I wanted some cash on hand.”

Isaac felt the same impulse to hoard cash in a crisis that others have. The irony is that he, better than anyone, knows the consequences for banks if others follow his lead.

Too much hoarding leads to liquidity crunches in markets big and small. Enter the Federal Reserve Board and its alphabet soup of facilities.

“One thing the Federal Reserve does is trying to make sure that there’s so much money in the system that it will satisfy even the most conservative of people,” he says.

Isaac points out that regulators have never faced a crisis like this. The Fed was only five years old when the Spanish Flu broke out in 1918, and the FDIC wasn’t created until 1933.

“The Fed is basically creating pages in their playbook that nobody thought were there,” Isaac says.

It’s been two months since regulators opened their playbooks and pulled out their toolboxes, with several of the lending facilities they created already acquiring assets. This is on top of the billions that Congress has offered in two rounds of stimulus, with the potential for more.

Much uncertainty remains, but the outlook for financial markets seems to have reached a precarious equilibrium.

Now we wait. For people to get better. For cities and businesses to reopen. For it to feel safe to be near strangers again. For the toilet paper to return to shelves.

At least the banks (and William Isaac) are flush with cash.

Kiah Lau Haslett / managing editor for Bank Director

Trump wants negative rates — but what would that mean for your wallet? by Ben Popken published by NBC News

Trump wants negative rates — but what would that mean for your wallet? by Ben Popken published by NBC News

May 16, 2020
Previously seen as a sort of theoretical thought experiment and a line that should never be crossed, some countries have experimented with setting negative interest rates.

Imagine a backward world of “negative interest rates” where banks charge you to save your money and pay you to take loans. Now forget it, because that’s never going to happen, even though that seems like the back-of-the-envelope implication of the unconventional monetary policy called for by President Donald Trump in tweets and rejected by Jerome Powell, head of the Federal Reserve, which sets U.S. monetary policy.

One of the main levers the Federal Reserve uses to influence the economy is by setting the federal funds rate, the interest rate banks charge each other to borrow. This one rate is in turn used as a benchmark for banks on a wide variety of products from the credit cards in consumers’ wallets to the loan for the car they drive and the interest earned by the nest eggs in their accounts.

Loans are more expensive for a borrower when rates are high, and cost less over time when rates are low. The only thing less than zero is a negative.

That’s got some people excited that negative rates could be the secret to juicing an American economy reeling from coronavirus shutdowns, skyrocketing unemployment, and plunges in spending and risk-taking.

“As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the ‘GIFT.’ Big numbers!” Trump tweeted on Tuesday.

Despite the pressure, Powell maintained his course of action, saying Wednesday that negative rates are “not something we’re looking at,” during a webcast with the Peterson Institute for International Economics.

Social media has reacted to the prospect of ever lower rates with jokes about “negative interest rate credit cards” that earn you money the more you shop.

“Will the interest rate on my credit card and student debt go negative too? Will I receive interest payments for borrowing money!!!? Is this a dream!?” tweeted Twitter user PubliusValerio.

“Stimulus for the people, everyone gets a 10K limit 25% negative interest rate credit card,” tweeted Twitter user Ken Wood.

Previously seen as a sort of theoretical thought experiment and a line that should never be crossed, the central bankers of some countries, notably slow-growing economies such as Japan and Switzerland, have experimented with setting negative interest rates.

“Negative interest rates are intended as a disincentive for people to hold cash instead of using money to purchase goods and spend money,” said William Isaac, a former Federal Deposit Insurance Corporation chairman, and co-chairman at the Isaac-Milstein Group. “The central banks of the world have gotten into a very bad place, beginning with highly unorthodox monetary policies during the crisis of 2008-2010. They don’t have many tools left to stimulate economic activity.”

These tools were effective in avoiding deflation, according to a paperby the Committee on the Global Financial System, though they did squeeze bank profits.

But “there is little if any evidence that negative rates actually stimulate growth, inflation, or improve bank lending,” said David Lebovitz, a global market strategist at JPMorgan Asset Management.

Long-term effects of negative interest rates can’t be fully determined either, the paper also warned.

It can be determined that setting rates to negative wouldn’t upend the cornerstone of banking where banks charge you interest on loans and pay you interest on deposits.

“Negative interest rates won’t filter down to the consumer level,” said Greg McBride, chief financial analyst for Bankrate.com. “No one is going to pay you to take out a loan, and banks will not charge money to put in a savings account.”

No one is going to pay you to take out a loan, and banks will not charge money to put in a savings account.

Banks could make up for the loss in lending income by increasing fees on checking accounts, overdrafts, ATM withdrawals, wealth management and mortgages.

“If we did see negative rates here, they would probably not impact the average consumer right off the bat,” Lebovitz said. “The experience in Europe suggests that only bank clients of a certain size would be subject to negative rates; everyone else would simply earn zero.”

For now, the Fed continues to push back against suggestions of a negative interest rate, and Powell said he believes it has plenty of tools left in its toolbox to help guide the economy.

Even if the rate is not negative, it does appear that a low interest rate environment is here to stay. Consumers with savings can try to stay competitive with inflation by putting their money in a high-yield online savings account.

But they should avoid money market funds, which “become an even worse alternative than they are now the lower rates go,” McBride said. “The yields are currently racing toward zero — and what happens to those funds in a negative rate environment is the trillion dollar question.”

FDIC tool to prevent bank runs goes unused vs. coronavirus by Brendan Pedersen published by American Banker

FDIC tool to prevent bank runs goes unused vs. coronavirus by Brendan Pedersen published by American Banker

May 15, 2020

WASHINGTON — Congress gave the Federal Deposit Insurance Corp. approval in March to intervene if the coronavirus pandemic triggered bank runs or other liquidity strains, but nearly two months into the crisis deposits are through the roof and the FDIC has shown no sign of acting on its expanded authority.

The culprit for now is a lack of need, analysts say. Unlike in the 2008 financial crisis, there is currently no shortage of liquidity in the nation’s banks.

“The banking system doesn’t have a liquidity problem like it normally would in an economic crisis where banks have made a bunch of bad loans,” said William M. Isaac, former chairman of the FDIC and co-founder of the Isaac-Milstein Group. “This is a crisis that started in hospitals and in nursing homes.”

Research shows that 37% of all consumers, and more than 50% of millennials, prefer to open a new account online.
The onset of the virus brought fears of deposit outflows on top of other liquidity concerns. The Federal Reserve acted quickly with emergency liquidity backstops for key areas of the financial system, such as corporate and municipal bonds.

For an added safeguard, the Coronavirus Aid, Relief, and Economic Security Act authorized the FDIC to reinstate 2008-era programs to back all noninterest bearing transaction deposits as well as bank-issued debt.

But in stark contrast to the 2008 financial crisis, the pandemic crisis hasn’t threatened bank liquidity. On the contrary, bank deposits have ballooned to unprecedented levels, likely in part because investors have fled a volatile stock market in search of safety.

“It’s possible a liquidity crisis will develop, so regulators will probably watch from the sidelines and be ready to bring out tools if they’re needed,” Isaac said. “But I’m not sure they’ll be needed.”

In 2008, the FDIC used authority it had at the time to launch the Temporary Liquidity Guarantee Program — made up of the Transaction Account Guarantee Program and Debt Guarantee Program — as the credit crunch brought on by massive mortgage losses shook the nation’s confidence in the banking system. Congress in 2010 required the FDIC to seek approval before re-launching the programs.

Yet since Congress reauthorized those backstops in March, the FDIC has not appeared to consider launching either program.

In the two months since the pandemic first took hold in the U.S., deposit levels have exploded. According to the most recent data from the Federal Reserve, deposits at commercial banks hover around $15.1 trillion dollars, up from $13.2 trillion at the start of the year, or an increase of about 14% in just under four months.

On a week-to-week basis from mid-March to late April, deposits grew at a clip never before seen in available Federal Reserve data. Since 1973, the nation’s deposits in commercial banks have grown by an average of about 0.13% a week. But in the seven weeks between March 11 and April 29, weekly growth averaged 1.57% — roughly 12 times the historic average, and the largest seven-week period of deposit growth on record.

Today’s picture of bank liquidity is a far cry from anecdotal reports of cash runs and deposit outflows that percolated in the early days of the pandemic. Fears of a cash crunch were palpable enough that the the FDIC sought to address depositors in a March 24 video bulletin from Chairman Jelena McWilliams, who told bank customers that the “last thing you should be doing is pulling your money out of the banks now, thinking that it’s going to be safer someplace else.”

Some observers pointed out that the FDIC’s nod from Congress to redeploy liquidity programs was not a mandate so much as an unlocked door.

“The CARES Act was the first major piece of the federal response and was meant to be a stabilizing force with the crisis. Part of that is going back to your old tools and making sure they’re ready when they’re needed,” said one industry source. “It was Congress’s way of saying, if you need this, we support it.”

Others cautioned that a full-fledged financial crisis as a result of the pandemic was still a distinct possibility, particularly for community banks.

“Even if the 2008 financial crisis was fundamentally different than the current public health crisis, COVID-19 could have the same ultimate impact on banks that the last crisis did if this drags out and creates concerns about the financial strength of banks in the marketplace,” said Brian R. Marek, a partner at Hunton Andrews Kurth. “Community banks are still concerned about the potential for their customers to start withdrawing large amounts of cash.”

Marek said that it was “a bit disappointing” that the regulators hadn’t signaled how they were prepared to act if any temporary liquidity action became necessary for the financial system to weather the economic slowdown.

“Some kind of action from the FDIC, especially in this low interest rate environment, that expanded deposit insurance for all non-interest-bearing accounts would be a much more persuasive sign to consumers at large that their money is safe,” he said. “This is about the FDIC demonstrating the strength of the financial system and assuring depositors that their banks are a safe haven.”

But others emphasized that given the uncertainty in the months ahead, it may be too early for measures like the FDIC’s temporary liquidity guarantees. They note that the 2008-era programs were born of a financial crisis and focused on keeping the financial system’s plumbing intact.

“Right now, the interbank lending market is working,” said Luigi De Ghenghi, a partner at Davis Polk. “The big thing about the Temporary Liquidity Guarantee Program during the last crisis was, more than almost any other tool, it allowed bank holding companies and banks to issue debt in the capital markets and helped unblock the interbank lending market.”

Isaac | Milstein Letter to Congress, May 8, 2020

Isaac | Milstein Letter to Congress, May 8, 2020

May 8, 2020

 

 

We recently shared an article with you written by us for the American Banker expressing our deep concern about the Current Expected Credit Losses standard (“CECL) and about the role played in setting accounting standards by the Financial Accounting Standards Board (“FASB”).

As you might know, FASB is a completely private sector board created in 1973 by the accounting industry without any meaningful oversight from Congress, the Administration, or the government agencies charged by Congress with regulating the financial system, including the Federal Reserve, the FDIC, the Comptroller of the Current and the Department of Treasury, and the National Association of Credit Unions.

FASB proposed in the 1990s to require financial institutions to adopt market to market accounting rules. The heads of the Federal Reserve Board (Alan Greenspan), the Department of the Treasury (Nicolas Brady), and the FDIC (William Taylor) unanimously spoke out against the proposed new accounting rules, arguing, correctly, that our nation had mark to market accounting rules before and during the Great Depression, and the rules were eliminated by President Roosevelt in 1938 because market based accounting was preventing a recovery from the Depression. There is no question in the minds of unbiased/knowledgeable observers that FASB’s mark to market rules (mislabeled by FASB as “fair value accounting”) forced regulated financial institutions to needlessly write off $500 billion of private capital at the beginning of the economic downturn in 2007-2009. This $500 billion write down created massive instability in the financial system and wiped out roughly $5 trillion of lending capacity, forcing Congress to enact the $700 billion TARP program. We need to put the accounting rules governing our nation’s federally insured depository institutions back into the hands of the SEC, which must be required to work closely in developing and overseeing these rules with the Federal agencies charged with supervising our nation’s critically important financial institutions.

Finally, we are pleased to provide another compelling article on this topic written by Scott Shay, Chairman of Signature Bank, and published earlier this week by the American Banker entitled, “Time for Congress to Put an End to CECL.” We hope you will find FASB’s usurpation of regulatory and accounting rules affecting Federally insured depository institutions of significant concern, as we certainly do. We will be available to discuss in further detail as appropriate.
Best regards and hope you are safe and healthy.

William M. Isaac
Co-Chairman
Howard P. Milstein
Co-Chairman


Time for Congress to put an end to CECL

by Scott A. Shay

The Financial Accounting Standards Board is considered by people who actually do business to be ridiculously out of touch.

Sadly, FASB has proved this again. The FASB seems to spend its time deriving increasingly more fiendish and complex accounting standards. These new rules place an even heavier burden on the private sector, with little regard for cost versus benefit or practicality for a typical company. Neither does it recognize relevance to banks and investors who use the financial statements.

The FASB standards best suit the largest corporations: those that have large accounting staffs and can afford to pay a myriad of consultants and modelers to cope with the latest pronouncements. The recent 
FASB-induced fiasco is the imposition of its so-called Current Expected Credit Losses accounting standard, with a first quarter 2020 implementation that comes at the worst possible time.

The CECL standard requires U.S. companies to pretend to employ prophets as it mandates that banks predict and set aside reserves at the closing of loans for potential losses throughout the life of the loan.

In the absence of certifiable prophets, firms must hire modelers to make predictions over extremely long-term periods. These models are typically very precise and broadly inaccurate. And the models do not relate to the changing real world, especially what is confronting businesses and the economy now — a massive recession induced by COVID-19.

According to the FASB, these models have to be constantly tinkered with over time and will presently force banks to significantly reduce their capital. With CECL, capital is reduced in bad times and increased in good times.

It is exactly the type of pro-cyclical accounting that any country should avoid for its own good.

Contrary to the objective of all the stimulus efforts being put forth by the U.S. government and the private sector, the CECL standard will likely reduce loans which could have otherwise been made during this crisis.

The CECL is built in a way in which the effects will continue to reduce lending by decreasing capital in accelerating amounts as loan loss reserves are added. Therefore, the deeper the COVID-19 recession gets, the less capital CECL will make available for lending.

Even with this clear and present crisis, FASB is moving full steam ahead with its implementation.

There are bills in Congress designed to delay or abolish CECL. But the fact that the FASB has not taken one step to at least delay CECL is astonishing.

One wonders if the FASB is so socially distanced from the real world that they think they are living on another planet, and are merely clinically curious about the crisis happening to everyone else. In fact, it is the FASB’s own actions, or inaction in this case, which will make the crisis worse.

Furthering the problem, the CECL standard could become more difficult to compare results across U.S. banks and financial institutions; or at least between the U.S. and the rest of the world.

The multitude of employed reserve methodologies make comparison almost impossible. The FASB, undeterred by any of this, seems so convinced by its own brilliance that it has ignored the groundswell of many comments from practitioners and investors who’ve overtly pointed out the obvious issues in creating such a model-intensive component of financial statements.

Congress must take action to help rebuild the economy without spending even one dollar of taxpayer funds: abolish CECL.

Scott A. Shay
Chairman and Co-founder, Signature Bank of New York

Source: https://www.americanbanker.com/opinion/time-for-congress-to-put-an-end-to-cecl

Suspend the Payroll Tax by Steve Forbes, Arthur B. Laffer, Ph.D. and Stephen Moore

Suspend the Payroll Tax by Steve Forbes, Arthur B. Laffer, Ph.D. and Stephen Moore

April 24, 2020

The best economic idea we’ve heard in response to the coronavirus crisis is a payroll-tax suspension. President Trump restated his support for it at a recent press briefing, and for good reason: It would reward work and production rather than the growth of government. Republicans should rally around the idea as the centerpiece of their next economic revival plan.

The plan we recommend would cancel all payroll-tax collections from May 1 to the end of the year. This would suspend the Social Security and Medicare tax, known as FICA, which takes 7.65% from a worker’s paycheck, with another 7.65% paid by employers, up to $137,700 of income. Self-employed Americans, usually socked with the full 15.3% payroll tax, would also find relief.

Every worker in America would get a substantial pay raise for the remainder of the year, but because the tax is regressive, lowest-wage workers would be helped the most. The majority of low- and middle-income workers pay more payroll tax than income tax. Even minimum-wage workers would see a nice boost in their paychecks while their employers would pay less too.

By reducing employer payroll costs, this plan would encourage firms to start hiring. Several economic studies document what common sense would tell us: Lowering the tax on employment leads to more of it. Because the tax relief would be temporary, businesses would gain an incentive to hurry up and hire right away, or as soon as their work resumes. There is no time to waste: The U.S. needs to put perhaps 20 million people back to work.

This would help firms without picking winners and losers. Unlike almost every other “stimulus” plan—to bail out airlines, banks, Boeing, energy companies and the rest—suspending the payroll tax provides an equal benefit to every company in America.

Also important is its ease of implementation. By simply not taking some $800 billion from the businesses and workers on Main Street, this plan cuts out the bureaucratic middlemen who plague spending programs. Our previous research leads us to expect that this would be at least 20% more efficient than collecting the money from taxpayers, running the funds through the federal maze, and then distributing them through various spending programs.

We have heard the objections. One is that this will drain the Social Security and Medicare trust funds. But the Treasury would transfer money from the general fund to these programs, fully making up the shortfall. Benefits for seniors now or in the future wouldn’t be threatened.

Another is that it would be too costly to let workers and businesses keep $800 billion of their own money. But compared with the few trillion dollars Congress would otherwise spend on more government relief programs, the payroll-tax suspension is a bargain.

The other complaint is that House Speaker Nancy Pelosi would never go for this plan. Maybe, but this would forfeit the moral high ground completely. Suspending the payroll tax would give every minimum-wage and middle-class worker—most of whom have faced great hardship this year—a swift rise in their paychecks, starting immediately. If Mrs. Pelosi and her colleagues want to oppose that, let them.