June 18, 2024

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The 2008 financial crisis did not prepare us for the 2020 coronavirus crisis

As the coronavirus panic unfolded, the Trump administration was among the first to second-guess lawmakers’ post-crisis restrictions on regulators’ bailout authority.

While the 2008 meltdown spurred Congress to give agencies many new ways to intervene in the financial system, a political backlash — from Republicans as well as many Democrats — over the rescue of Wall Street banks spurred lawmakers to impose new hurdles if regulators were compelled again to save firms from collapse.

Congress limited the Federal Reserve’s authority to provide emergency lending to individual companies outside the banking industry, as it had done with the giant insurer American International Group in 2008. Lawmakers also restricted Treasury’s ability to guarantee money market mutual funds as it did during the crisis.

Dodd-Frank called for the Fed’s emergency lending power to be used on a broad basis for several firms at once, not to bail out a single insolvent company. And the central bank would have to seek the Treasury secretary’s approval for emergency lending going forward.

The restrictions have come to the fore as the Trump administration scrambles for ways to prop up ailing companies, including airlines.

“I am in daily conversations with [Fed Chairman] Jay Powell,” Treasury Secretary Steven Mnuchin said in a Fox News interview Sunday. “We are looking at the tools we have, and they are looking at the tools they have. Certain tools were taken away from both of us after the financial crisis with Dodd-Frank. If we need more tools, we will go back to Congress and get bipartisan support to get that.”

Mnuchin’s not alone.

Hal Scott, who has advocated for financial industry deregulation as director of the Committee on Capital Markets Regulation, argued in The Wall Street Journal that Congress should restore all the powers it took away from the Fed, as well as the Treasury Department and the Federal Deposit Insurance Corp. “Bold action can prevent a panic before it starts,” he said.

Former Federal Reserve Governor Kevin Warsh called on the Fed to invoke its emergency powers to create a new credit facility to ensure businesses and households have access to cash, a move that could benefit airlines, retailers and energy companies hit by the economic shutdown — not just banks and financial institutions.

But if congressional authority is needed to arm the Fed with new bailout powers to rescue failing corporations, expect resistance from lawmakers and howls from Wall Street watchdogs.

Sen. Elizabeth Warren (D-Mass.) and progressive advocates are already warning that any bailouts of big business should be accompanied by higher wages for workers and restrictions on payouts to investors.

“Let me be clear: We’re not doing no-strings-attached bailouts that enrich shareholders or pay CEO bonuses,” Warren said Tuesday. “Period.”

Powell himself said Sunday that the Fed had not made the decision to request further authority from Congress.

Fischer, who is policy director at the Washington Center for Equitable Growth, said the Fed’s emergency lending power isn’t that constrained.

“The Fed will do what it takes in a downturn to stabilize the financial sector,” she said. “Who has standing to sue them to undo it? No one would sue them, no one would challenge them.”

Unlike 2008, the banking industry does not appear to be in dire need of a government rescue. How long the industry remains on solid footing will depend on how effectively lawmakers and regulators shored up the banking system over the past decade.

Bank CEOs, including Brian Moynihan of Bank of America and Michael Corbat of Citigroup, visited President Donald Trump at the White House on March 11 and repeatedly stressed that their banks are well-capitalized and ready to make loans to businesses and help struggling consumers.

But an economy veering toward a recession will test whether the banks’ buffers will be enough to help them follow through on those promises. The banks are facing major pressure on their margins from rock-bottom interest rates and will have to deal with borrowers unable to pay back loans.

The implementation of the past decade’s banking safeguards was a constant lobbying fight, with regulators, banks and consumer groups battling over what constituted adequate capital and liquidity. In 2018, Republicans and moderate Democrats enacted legislation that further eased some of those rules.

“We may have to find out there’s well-capitalized for regulatory purposes and then there’s well-capitalized in practice — for lending purposes and market purposes,” said Graham Steele, director of the Corporations and Society Initiative at the Stanford Graduate School of Business and a former aide to Senate Banking Committee ranking member Sherrod Brown (D-Ohio). “That’s the one tension I’m worried about.”

In addition to shoring up the internal operations of the banks themselves, regulators have spent the past several years implementing new powers to oversee a broader set of potential risks in the financial system.

One of Dodd-Frank’s biggest changes to Wall Street oversight was to regulate derivatives contracts known as swaps that financial firms and nonfinancial firms enter into to hedge risk and place speculative bets. Lawmakers imposed new regulations on the market after uncertainty about derivatives positions led to the near-failure and subsequent bailout of AIG in 2008.

The weeks and months to come will pose a major test for the market’s primary regulator — the Commodity Futures Trading Commission — and its ability to keep tabs on potential risks that might be building. It has struggled since taking on the new derivatives mandate because of budget cuts imposed by Congress.

The CFTC now receives trading data on the swaps market but the agency still doesn’t have complete awareness of everything going on, said Justin Slaughter, a former commission official and ex-Senate aide who’s now a consultant at Mercury Strategies.

“We’re no longer flying blind, but I wouldn’t say the CFTC has got a truly clear window into what’s going on in real time,” he said. “It might be more accurate to say we’re flying with one eye open.”

One of the most powerful entities Congress created in 2010 was the Financial Stability Oversight Council. The council, tasked with identifying systemic risks, includes the heads of the Federal Reserve, Securities and Exchange Commission, FDIC and CFTC.

It was empowered not only as a convening body, but also with the power to place “systemically important” financial firms under the Fed’s oversight and to pressure individual regulatory agencies to implement new rules. Trump’s appointees have signaled that they have no intention of using the power to subject new financial institutions to Fed oversight.

Coronavirus is the biggest crisis the group has faced yet. Since the pandemic exploded, the council has been quiet. It’s scheduled to meet March 23, and lawmakers are now pressing the council to act.

“FSOC does not inspire a lot of confidence,” Fischer said. “It’s interesting to me the president has taken such a market-centered approach to the pandemic. He’s met with Wall Street CEOs. That’s clearly the focus of his attention. But there’s not been similar attention paid by regulators to market stability.”

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