Fed Can't Backtrack On Regulatory Reforms

George Yacik - INO.com Contributor - Fed & Interest Rates

I’ve been pretty harsh in this column on Federal Reserve monetary policy, but the one area that I haven’t written much about– financial regulation – is probably the main area where the Fed does deserve a lot of credit.

In her speech at the Jackson Hole symposium late last week, Fed Chair Janet Yellen probably disappointed a lot of market watchers for her failure to talk about interest rates or unwinding the Fed’s balance sheet. Instead, she spent most of her speech defending the Fed’s actions in the regulatory realm in the wake of the global financial crisis and pushed back against critics who want to roll back those regulations, including President Trump, who vowed that he wants to “do a big number” on Dodd-Frank.

If Yellen wants to be reappointed to her position by Trump when it ends in February, she certainly didn’t sound like it. Then again, making comments in opposition to Trump is hardly a heroic stance.

Still, she deserves credit for defending the Fed’s position on bank regulation, and the next Fed chair, whether it’s Yellen, Gary Cohn, or someone else, should stick with the current policy, which will go a long way toward keeping our banking system safe and secure and make sure that the global financial crisis doesn’t repeat itself. After all, if you can’t trust keeping your money in a bank, nothing else matters.

“The events of the crisis demanded action, needed reforms were implemented, and these reforms have made the system safer,” Yellen said in her prepared remarks. “The balance of research suggests that the core reforms we have put in place have substantially boosted resilience without unduly limiting credit availability or economic growth. Because of the reforms that strengthened our financial system, and with support from monetary and other policies, credit is available on good terms, and lending has advanced broadly in line with economic activity in recent years, contributing to today’s strong economy.”

Let’s not forget, however, that the Fed – then headed by Alan Greenspan – was one of the perpetrators of the financial crisis. It failed to raise interest rates soon enough, allowing the housing bubble to grow and failed to rein in reckless mortgage lending that set off the crisis. The Fed, after all, is responsible for regulating the very biggest banks. So a lot of these subsequent reforms were done to correct the Fed’s own mistakes.

That, of course, is the main reason that nobody in the financial services industry – not Angelo Mozilo, not anybody – went to jail for their roles in the financial crisis, which those calling for their heads always fail to acknowledge. It’s hard to charge people with crimes when it was the government itself – Fannie Mae and Freddie Mac, primarily, but also the Fed and other regulatory agencies – that either actively encouraged lenders to make unaffordable loans or did nothing about it when they did. It was only after many horses – and lots of vicious, aggressive animals – had left the barn did regulators move to shut the door.

Opening it again, even a little bit, is therefore not a good idea. If we want to make sure that a global financial crisis on the scale of 2008 doesn’t repeat itself, we need to retain the reforms that have been made since. Otherwise, we’ll be condemned to relive the past – maybe not soon, but eventually.

Some of these new regulations, it’s true, do need to be scaled back a bit, but only as they apply to small and medium-sized banks that had little to do with causing the financial crisis but are being held to the same standards as the bigger ones that did.

This includes the Volcker rule, which the big banks are particularly insistent upon changing. And it’s not hard to see why. They want to be able to engage in risky – and therefore usually highly profitable – proprietary trading for their own account even as their deposits are insured by the federal government, which of course will be responsible for cleaning up any mess if these trades aren’t only not profitable but disastrous. We certainly don’t need to go back to that again. The banks can’t have it both ways. Either you’re a bank or a trading firm – you can’t be both.

The one area where the Fed has failed is not doing anything about reducing the size of the biggest banks, which are now even bigger and potentially more dangerous to the financial system than ever. The Fed also hasn’t done a whole lot about punishing bad actors that still populate the industry, like Wells Fargo. Compared to its many sins – which are still seeping out on a seemingly weekly basis lately – Wells has gotten off pretty lightly in terms of legal penalties.

As we’ve seen from the results of the Fed stress tests announced recently, regulations that keep banks safe turn them into cash cows, which bankers may find boring but which is great news for investors in their stocks. Indeed, owning bank stocks that reliably pay dividends in the 5% range – as they used to do – are a great alternative to bonds. Let’s keep them that way.

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George Yacik
INO.com Contributor - Fed & Interest Rates

Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.