Where Fed's Powell breaks from Yellen on banking policy

Published
  • February 27 2018, 3:51pm EST
WASHINGTON — Federal Reserve Chair Jerome Powell largely hewed close to his predecessor Janet Yellen's positions in his first testimony Tuesday before Congress since being sworn in early this month, but also signaled important changes when it came to paying banks interest on reserves and other topics.

In more than three hours of Humphrey-Hawkins testimony before the House Financial Services Committee, Powell faced several questions that Yellen did, and in many cases furnished identical answers: the debt ceiling, he said, cannot be breached; the threshold for "systemically important" banks should be raised; the Federal Reserve’s current makeup and monetary policy process has served the nation well; certain problems, such as fiscal policy, are outside the purview of the Fed.

But Powell veered off in other areas. Following are key takeaways from his testimony.

Fed paying interest on reserves not set in stone

One of the most important changes concerns the Fed's policy, adopted during the financial crisis, of paying banks interest for their excess reserves, which has become arguably the most important way the central bank sets interest rates overall.

House Financial Services Committee Chair Jeb Hensarling, R-Texas, wasted little time in asking Powell whether that policy — which was established in large part because open market operations were rendered ineffective during the housing crisis — ought to be phased out as the Fed’s balance sheet is returned to a more traditional level, with interest on excess reserves remaining “the fire extinguisher behind the glass that you break out in times of emergency.”

Powell said the Fed is examining that question.

“We have not made a decision in the longer run whether that will continue to be our framework, or whether we will return to something more like what we did before the crisis,” Powell said. “I don’t expect to be returning to that decision in the near term. I will just say that our current approach seems to be working very well; it gives us control over rates in a way that markets seem to understand.”

Powell’s comments are in stark contrast to Janet Yellen’s more forcible defense of interest on excess reserves, which she said earlier this year the Fed “absolutely" needs to implement it monetary policy objectives.

WASHINGTON — Federal Reserve Chair Jerome Powell largely hewed close to his predecessor Janet Yellen's positions in his first testimony Tuesday before Congress since being sworn in early this month, but also signaled important changes when it came to paying banks interest on reserves and other topics.

In the nearly three-hour Humphrey-Hawkins testimony before the House Financial Services Committee, Powell faced several questions that Yellen did, and in many cases furnished identical answers: the debt ceiling, he said, cannot be breached; the threshold for "systemically important" banks should be raised; the Federal Reserve’s current makeup and monetary policy process has served the nation well; certain problems, such as fiscal policy, are outside the purview of the Federal Reserve.

But Powell veered off in other areas. Following are key takeaways from his testimony:

Fed paying interest on reserves not set in stone

One of the most important changes concerns the Fed's policy, adopted during the financial crisis, of paying banks interest for their excess reserves, which has become arguably the most important way the central bank sets interest rates overall.

House Financial Services Committee Chair Jeb Hensarling, R-Texas, wasted little time in asking Powell whether that policy — which was established n large part because open market operations were rendered ineffective during the housing crisis — ought to be phased out as the Fed’s balance sheet is returned to a more traditional level, with interest on excess reserves remaining “the fire extinguisher behind the glass that you break out in times of emergency.”

Powell said the Fed is examining that question.

“We have not made a decision in the longer run whether that will continue to be our framework, or whether we will return to something more like what we did before the crisis,” Powell said. “I don’t expect to be returning to that decision in the near-term. I will just say that our current approach seems to be working very well; it gives us control over rates in a way that markets seem to understand.”

Powell’s comments come in stark contrast to Janet Yellen’s more forcible defense of interest on excess reserves, which she said earlier this year the Fed “absolutely need[s]” to implement it monetary policy objectives.

Fed considering next steps on leveraged lending guidance

Powell also was asked what federal banking regulators are going to do about guiding institutions on leveraged lending transactions, which was the subject of a 2013 interagency policy guidance that had been roundly criticized by congressional Republicans as an overreach that amounted to a rule rather than a guidance.

The Government Accountability Office issued a letter late last year to Sen. Pat Toomey, R-Pa., saying that the guidance was effectively a rule, and as such should be subject to congressional oversight as part of the Congressional Review Act. Because it was not given that review — and because many of the agencies who had issued the guidance had experienced a change in leadership since its publication — the guidance entered a kind of legal limbo of being effectively nullified but with no replacement readily apparent.

Powell said that the Fed had instructed its supervisors to disregard the guidance and is considering putting out a proposal for comment, though he was not clear about whether that proposal would resemble the previous guidance or would look different.

“In the case of the leveraged lending guidance, we do accept and understand that that is nonbinding guidance, and in fact since the GAO ruling, we have made a point to go out and make sure that message is getting out to supervisors and banks,” Powell said. “We are also … in discussions and thinking about other ways to underscore that, perhaps putting it out for further comment.”

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Custody banks likely to be granted relief from leverage ratio

Powell said that he expects that whatever changes the Fed and other regulators make to the enhanced supplementary leverage ratio to be directed at reducing the disproportionate burden that custody banks face from that capital requirement.

A leverage ratio is a simple capital metric that does not take into account the quality of the assets a bank holds, simply their nominal value. Thus a bank may be required to hold capital against any asset, including exceedingly safe ones like Treasuries and even cash. For custody banks — whose business model relies on high-volume, low-margin but exceedingly safe operations — the leverage ratio is a particular concern.

Rep. Randy Hultgren, R-Ill., asked Powell whether he favored a bill passed out of the committee that would “provide relief from the leverage ratio for banks predominantly in the business of providing custody services,” but Powell said the Fed is working to provide that relief administratively so that no legislation would be necessary.

“I agree with you that the leverage ratio can deter banks from engaging in low-risk wholesale activities, particularly the custody banks. We have looked carefully for some time now at how to provide relief, and our preference for the way to do that is to just recalibrate the enhanced supplemental leverage ratio and custody banks would feel significant relief.”

Powell’s comments are generally in line with comments Yellen made last July, where she suggested that the supplementary leverage ratio may be too high for custody banks and may have inflicted unintended consequences on those institutions.

“These two things do need to be calibrated appropriately so that the risk-based capital is what's binding, and we are looking at the calibration of that supplementary leverage ratio,” Yellen said. “For example, it affects the custody banks and may be having some unintended adverse consequences.”

Republicans want the balance sheet normalized, and fast

Several Republicans on the committee asked Powell about the pace and timing of the Fed’s ongoing draw-down of its balance sheet, which the central bank ran up as a response to the financial crisis.

Hensarling took aim at the Fed’s balance sheet in his opening statement, saying that he is uncertain about the Fed’s plan and ability to roll off its balance sheet — which swelled from less than $900 billion before the crisis to a peak of roughly $4.5 trillion — when the economy is not in a crisis.

“There is clearly concern now whether the Fed can successfully unwind a historically ‘unbalanced’ balance sheet after a decade of radically unconventional monetary policy and artificially low interest rates,” Hensarling said. “This was not particularly an issue when the economy was stuck in low gear. But now that the economic transmission has been shifted into high gear, it clearly is an issue.”

Rep. Andy Barr, R-Ark., who chairs the committee’s monetary policy panel, asked Powell whether the Fed has any plans or contingencies to sell its assets — rather than simply allowing them to mature — in order to combat a flattening yield curve. Powell said that flattening yield curves can be expected with the rising of short-term rates, and he did not anticipate changing the balance sheet trajectory from what the Fed has initiated last fall.

“I certainly feel our balance sheet normalization plan is carefully crafted and carefully rolled out, and markets took it without much of a reaction, and I would have little inclination to change the general parameters of it,” Powell said.

Democrats hammered Powell on uneven distribution in a strong economy.

Several Democrats on the committee invited Powell to comment on the economic impacts of the Trump administration’s most recent fiscal policies, including a tax bill passed late last year and the more recent bipartisan two-year budget deal. The line of questioning is likely one that Powell will have to acquaint himself with, even if he believes, as he suggested, that those issues are peripheral to his mandate as Fed chair.

Powell was asked on a number of occasions to account for disparities between racial minorities and white Americans, as well as broader issues of income inequality and stagnating wages. Powell noted that issues like stagnant wages can be a reflection of a flattening of educational attainment and other indicators that tend to lead to higher worker productivity, and by extension, wage growth.

Rep. David Scott, D-Ga., pressed Powell about the uneven benefits of the tax bill, saying that by far the greatest beneficiaries were wealthy investors and private companies while many poor and minority communities are expected to reap few benefits. He said that fiscal policy is further compounded by the president’s budget, which makes cuts to a variety of social safety net programs like food stamps.

“You know who is impacted the most because of these budget cuts? It’s the African-American community,” Scott said. “I want to ask you to get on our side, the side of the American people, because it is clear to me that this President Trump is not on the side of the American people. You tell me, Mr. Chairman, is this the way you think about America?”

Powell, pausing for a beat, said: “I can only say that these are very important issues, and I take it to heart. These are not issues we have authority over.”

“I was waiting for you to say that,” Scott said. “There’s nobody better suited. You are the chairman of the Federal Reserve. Do you know when you sneeze, Wall Street crumbles? You have a deep compassion for people. All I’m asking for you to do, is to, every once in a while to say, 'Hold on, Mr. President. This isn’t right.' "