Executive Intelligence Review


Inviting the Crash: Fed Regulator Makes Dangerous Mistake

Nov. 12, 2018 (EIRNS)—The Federal Reserve Vice Chairman for Supervision Randal Quarles spoke at a Brookings Institution event Nov. 9 and introduced rules changes for the biggest banks which repeat the Fed’s pre-2008 crash mistake and threaten to hasten another and bigger crash.

Quarles’s presentation covered a host of rules changes which, as he said, had been requested by the big banks themselves. The common denominator was to allow them to operate with less capital relative to their assets, and therefore with more debt leverage. A bank’s lending—producing its assets, of whatever quality—is funded either out of its capital, or out of its borrowing on bond markets; and the ratio of the latter to the former for the big Wall Street banks is currently about 22:1 on average. By contrast the average leverage ratio for community banks around the country is 12-15:1.

The biggest banks’ ratio was much higher a decade ago; tougher regulation, especially driven by the hard-driving FDIC regulator Thomas Hoenig, had forced it down and fought off European Union attempts to pull U.S. banks debt leverage back up. Hoenig wanted the new position of Fed bank regulator, which Quarles got; Wall Street knew the difference.

While Quarles’s account of what the new rules under consideration are, and when they may go into effect—anywhere out to 2021 or 2022—was detailed and could be confusing, it had a clear bottom line: The earliest rule changes will allow the biggest Wall Street banks to increase their debt leverage starting “in the very near future,” as Quarles put it. By adopting “risk adjustment” rules the EU has been using, the big banks’ assets will appear to be smaller than they actually are.

As both Hoenig and former FDIC chair Sheila Bair have stressed, the 2004 Fed policy change to allow the big Wall Street investment banks to increase their debt leverage above 30%, was the death star for the banking system. That system imploded four years later with Morgan Stanley and Lehman Brothers leverage ratios between 35:1 and 40:1.

With the corporate debt-centered “everything bubble” already ready to melt down now, this is a very dangerous mistake.