Federal Reserve Chairman Ben Bernanke presented his semi-annual report on monetary policy to the Senate Banking Committee on Feb. 26. The more intriguing scenario always occurs when he testifies first on the Senate side. In the summer, the schedule will be reversed, and there will probably not be as much value to the hearing, because the House will go first.
There are four categories of issues to dismiss or discuss right away:
Perhaps half of the senators wanted to be seen as making the point that sequester is a real shame, and that it would be better if policy were made in a more thoughtful way. It looked like they all wanted to make a clip for their local evening news. All of this has been said before, and the best way to use this hearing is to dismiss the “yada yada” about the sequester.
2. Quantitative easing (QE).
Several senators asked about how the Fed plans to unwind the extended period of monetary accommodation, as they played off reports of dissent within the Federal Open Market Committee. Bernanke acknowledged that the debate is taking place in public, and he insisted that the Fed “has the tools” to deal with this, probably by letting the assets slowly run off the Fed’s balance sheet and by paying interest on the reserves the banks hold at the Fed.
There is some doubt, however, that the Fed will be able to use its tools effectively. The value for viewers is to look at Bernanke’s comments and ask, what if the market raises interest rates more abruptly than the Fed intends or expects? What if the Fed loses control over the timetable or never really had it in the first place? At an event at the Philly Fed about a year ago, I casually asked an economist in attendance, suppose one assumes that the Fed intends gradually to increase rates by 400 to 500 basis points, but the market is only looking for a signal that the process has begun. Thus, as soon as the Fed raises the federal funds rate by 0.25 or 0.5 percent, the market spikes and takes much of the expected increase in one gulp. The economist thought that very well could happen.
So it would be an interesting exercise to game assumptions outside what the Fed expects and is trying to achieve. Similarly, an increase in rates could affect the projections as to the positive effect the transactions would have on the federal budget, as tailwinds turn into headwinds.
3. Regulatory issues.
Several senators asked about issues that remain regarding the implementation, or what I call the “limplementation,” of the Dodd-Frank Act 2 ½ years after it became law. Among the issues raised were whether the mortgage rules can be simplified; whether the overall regulatory burden on smaller banks can be reduced, which senators would love to do for their constituents; whether margin requirements will be imposed on end users of derivatives, which senators want to prevent; and whether the so-called “pushout” rules will take effect, which bankers will continue to resist.
These may be interesting matters for another day, but the big picture is that the industry has successfully resisted effective regulation every time major banking legislation has been hailed as putting an end to banking crises, but the legislation is never implemented. The industry has become more aggressive recently in presenting itself as the victim of the financial crisis, as it demands that regulations be scrapped in the interest of enabling economic growth. Nothing changes, and this is why the financial crisis will continue to fester. Therefore, the bigger story is when a new episode will occur and what will trigger it.
4. Too big to fail.
The most intriguing story of the day, and one that will probably be lost on the TV commentators, is that a bipartisan minority of senators is getting restive about what they see as the continued growth in the size and power of the largest, “too big to fail” banks. Senators who spoke up were Elizabeth Warren, D-Mass., David Vitter, R-La., Bob Corker, R-Tenn., who took another round at the end of the hearing to do this, and if Sherrod Brown, D-Ohio, had attended, he almost surely would have raised it.
The byplay became testy at times as senators tried to get across to the Bernanke that they are alarmed at the trends as found by authoritative entities like the International Monetary Fund, while Bernanke sought to reassure senators that the process is complicated and will take time. As the hearing ended, Corker said sharply that he disagrees with Bernanke and will follow-up with a letter. It is likely that several senators will write to Bernanke and urge that the issue of “too big to fail” be addressed with urgency rather than indifference.
The questioning could have been even sharper had it raised the issue in the context of dividend increases and stock buybacks that the banks expect regulators to approve this year. Another way the questioning could have been sharper is if the senators had stressed the poor track record of the Fed in predicting market behavior as the reason why they question the ability of the Fed to withdraw QE in an orderly way.
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