Fed chair faces Democratic fury over stress test results

WASHINGTON — Senate Democrats rebuked Federal Reserve Chairman Jerome Powell for the agency’s decision to withhold failing grades for three banks on this year’s stress test despite the fact that their capital levels fell below required minimums.

In Powell's semiannual appearance before the Senate Banking Committee Tuesday morning, Sen. Sherrod Brown, D-Ohio, the committee's ranking member, wasted little time blasting the Fed for what he described as an overly lenient approach.

Even though the test performances for Goldman Sachs, Morgan Stanley and State Street were subpar, Brown said in his opening statement, the Fed allowed all seven of the "largest banks to redirect $96 billion to dividends and buybacks” following the assessments.

Sen. Sherrod Brown, D-Ohio
Senator Sherrod Brown, a Democrat from Ohio, questions Steven Mnuchin, Treasury secretary nominee for U.S. President-elect Donald Trump, during a Senate Finance Committee confirmation hearing in Washington, D.C., U.S., on Thursday, Jan. 19, 2017. Mnuchin defended his record as an owner of a mortgage lender that was accused of unfair loan and foreclosure practices during the financial crisis. Photographer: Andrew Harrer/Bloomberg

Brown also criticized some of the ideas that Powell and Fed Vice Chairman for Supervision Randal Quarles have floated to change the stress tests, including opening the stress test scenarios to notice and comment periods and exempting even more banks from the qualitative stress test examination.

“Vice Chair Quarles has suggested he wants to give bankers more leeway to comment on the tests before they’re administered — that’s like letting the students help write the exam,” Brown said. “The Fed is considering dropping the qualitative portion of the stress tests altogether— even though banks like Deutsche Bank, Santander, Citigroup, HSBC and RBS have failed on qualitative grounds before.”

Committee Chairman Mike Crapo, R-Idaho, also asked Powell about the Fed’s rationale for not failing the three banks last month when the results for the Comprehensive Capital Analysis and Review were announced. Powell responded that this year’s test was especially stringent, and that the timing of last year’s tax law made the results idiosyncratically low for those firms and not representative of those banks’ actual capital positions today.

“This year’s test was, by a good margin, the most stringent test yet,” Powell said. “We labeled these as conditional nonobjections rather than objecting straight out to the plan. And we’ve done that … many times, and we thought that it was appropriate here.”

Powell also said two of the firms had to restrict their dividends to last year’s levels as a result of their performance in the stress test — a penalty that is equivalent to what would be meted out for banks that had failed the test in years past.

“Two firms that did not [restrict their dividends] were required to restrict their [capital] distributions to last year’s level,” Powell said. “That has always been the penalty for failing to meet the post-stress minimums. And that will require firms to build capital this year.”

Powell also pushed back on the idea that the Fed had somehow negotiated the terms of the banks’ qualified nonobjection with those firms, saying the agency arrived at the decision to sanction them the way they did on their own.

“We carefully evaluated the results, we voted on it June 20, and the next day the firms received a call from our staff, which informed them of the results and their options,” Powell said. “That’s the standard operating procedure that we follow every year. There is no negotiation, no haggling.”

But those explanations did little to quell criticism of the Fed’s handling of this year’s stress tests from Democrats on the committee. Brown said the various proposals the Fed has made to change the stress test, combined with the questionable results from this year’s test, have weakened a tool that Powell himself has held up as an example of valuable post-crisis supervisory innovation.

“The actions the Fed has taken under your tenure have undercut that,” Brown said. “How’s the public supposed to trust the stress test when the Fed has proposed all of those ways to weaken them?”

Sen. Elizabeth Warren, D-Mass., likewise chastised Powell for the Fed’s proposed changes to the stress test, likening bank capital and the stress tests to a “belt and suspenders” for maintaining the function of the banking system through a financial crisis.

“The Fed’s capital rules and stress tests are like a belt and suspenders: you can loosen the belt and rely on the suspenders, or you can loosen the suspenders and rely on the belt,” Warren said. “But if you do both, your pants will fall down. And as we learned, when the big banks’ pants fall down, it’s the American taxpayers and workers that are stuck pulling them back up.”

Powell also challenged Warren’s assertion that the Fed is reducing the banks’ capital requirements with its proposal to revise the enhanced Supplementary Leverage Ratio. He said the stringency of this year’s stress test satisfied him and his colleagues on the Fed board that the banks did not need to submit a revised capital plan.

“With respect, Senator, we’re not doing either of those things,” Powell said. “The stress test in 2018 was materially more stressful, and … the amount of capital required to pass the test was the highest, by far, of any test.”

“You know, I don’t know what to say,” Warren replied. “The data don’t seem to back you up on this.”

Powell also faced questions about whether he intended to loosen supervisory requirements for U.S. based affiliates of international banks — so-called intermediate holding companies — after the passage of the regulatory relief bill earlier this year raised the asset thresholds for U.S.-based Systemically Important Financial Institutions from $50 billion to $250 billion.

Powell indicated that there was no plan in place to change the IHC regulatory regime at all, though he shied away from promising that he would never change it during his tenure as Fed chair.

“I can’t say we won’t do anything to provide regulatory relief to a group in my tenure … but the $50 billion threshold for IHCs will remain the same,” Powell said. “We’re not looking at that. So I think they won’t see much difference.”

Powell also faced some questions — from Democrats and Republicans alike — on whether President Trump’s recent tariffs and more hawkish stance on trade are imperiling the U.S. economy. Powell was quick to note that trade was outside of the Fed’s purview, but told Sen. Tim Scott, R-S.C., that trade barriers tend to backfire on countries that erect them.

“It has significant effects on the economy,” Powell said. “I would say, in general, countries that have remained open to trade and haven’t erected barriers with tariffs have grown faster, had higher incomes, [and] higher productivity, and countries that have gone in a more protectionist direction have had a worse result.”

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Stress tests Minimum capital requirements Jerome Powell Sherrod Brown Elizabeth Warren Senate Banking Committee Federal Reserve Goldman Sachs Morgan Stanley
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