Bank regulators aren't doing enough to address economic inequality
A version of this post was previously published on the Federal Financial Analytics blog.
U.S. regulators have abandoned any thought of governing the financial system to reverse the seemingly inexorable slide into ever more economic inequality — as made clear by the Financial Stability Oversight Council’s new framework for systemically important institutions.
To be fair, the Obama administration didn’t use its power to make a difference any more than the Trump-appointed team proposes, but that’s no excuse.
Earlier this month, Federal Reserve Chair Jerome Powell insisted, as Ben Bernanke and Janet Yellen did before him, that the Fed is powerless to offset growing inequality no matter how much it wishes it could lend a hand.
But, as the FSOC’s proposal reminds us, neither the Fed nor the Treasury nor any other U.S. federal regulator is bound by an anti-equality straitjacket. Current law provides two powerful tools for equality-enhancing financial regulation that sweep the “wish we could” excuse off the table.
What tools? They are to be found in the same Dodd-Frank Act language that FSOC now wants to rewrite to make it virtually impossible to designate a SIFI or deem any activity a systemic risk. (Whether this makes sense is a debate for another day.) What matters for equality is that FSOC takes an even heavier sledge hammer to its equality powers as it does to its systemic ones.
Key to Dodd-Frank’s systemic reach and at the heart of FSOC’s proposed changes are provisions in Title I allowing FSOC to designate a nonbank financial company as a systemically important financial institution or to cite an activity or practice as warranting additional regulation.
Section 120, the activity standard on which FSOC now proposes principally to rely, says in part that: IN GENERAL.—The Council may provide for more stringent regulation of a financial activity by issuing recommendations to the primary financial regulatory agencies to apply new or heightened standards and safeguards ... for a financial activity or practice conducted by bank holding companies or nonbank financial companies under their respective jurisdictions, if the Council determines that the conduct, scope, nature, size, scale, concentration, or interconnectedness of such activity or practice could create or increase the risk of significant liquidity, credit, or other problems spreading among bank holding companies and nonbank financial companies, financial markets of the United States, or low-income, minority, or underserved communities.
The reference to vulnerable communities is also to be found in Section 113 of the Act, which allows designation based on the importance of a nonbank financial institution “as a source of credit for households, businesses, and State and local governments … and … as a source of credit for low-income, minority, or underserved communities, and the impact that the failure of such company would have on the availability of credit in such communities.”
What might be done with these powerful pro-equality tools? First, FSOC would do well to give them serious thought. None of its reports, pronouncements or actions since 2010 has taken this mission seriously even though President Obama said that inequality is the “defining challenge” of our times and President Trump promised to do something about it throughout his campaign.
Secondly, what about some positive change where post-crisis rules have demonstrated inequality effects without offsetting prudential benefits? For starters, take first-time mortgages, which are critical to wealth accumulation, and startup small-business loans, which are vital for income equality. Why not carve out a corner of the risk-based capital rules for equality-essential loans, following the example found in the limited authority for public welfare investments already authorized for national banks? As I mentioned a couple of weeks ago, I floated this a while back with a top bank supervisor, whose only concern was that this would make the risk-based rules too complicated. Given the hundreds of pages already in that section of the rule book, I think banks will manage just fine with a bit of flexibility yielding a lot of equality improvement.
Finally, an FSOC focus on equality should also lead quickly to sanctions for exploitative or predatory products. This then would reduce systemic risk — a twofer of considerable value. Dodd-Frank is generally seen as a safety-and-soundness standard, but Congress added the language above to these sections because it was painfully clear in 2010 that high-risk lending was a predicate cause of the 2008 catastrophe. It bears repeating here that inequality engenders financial crises. With the U.S. now awesomely unequal, FSOC really needs to recognize its anti-equality mandate if it wants to accomplish its systemic stability objective.