Quantitative Easing from November 2008 thru October 2014 bloated the Federal Reserve’s balance sheet by $4 trillion under Dr. Ben Bernanke and Dr. Janet Yellen. Yet, according to the St. Louis Federal Reserve Bank’s data, only 29 cents out of $1 of QE ever got to market. The Fed purchased bonds from financial institutions with the hope they would take the cash from the sale and make loans.
Yet, at the same time the Fed from 2006 when Bernanke came to the present imposed substantial increases in capital and liquidity regulation. This forced financial institutions to keep over 70% of the cash from bond sales on their books.
The Fed Funds rate has changed four times since 2015, since falling to 0.25% in December 2008. It now stands at 1.25%. Another 0.25% change appears imminent for December 2017.
So, will Jay Powell continue the same monetary policy as Bernanke and Yellen? Will Powell take an active part in influencing the future of the GSEs Fannie Mae and Freddie Mac, which he has identified publically as a concern? Or, like his predecessors, will he do nothing? Will Dodd-Frank-era regulations be kept in place by Powell? Will he consider more depositories as systemic risks, i.e. Navy Federal Credit Union?
Let’s see what Jay Powell has done and what he can be expected to do. Then let’s see how to plan for 2018.
Looking at Powell
Here are some points on Powell’s background:
1. He is an attorney by training, with his law degree from Georgetown. This contrasts to the four previous Fed chairs, for the past 38 years, who hold PhDs in economics.
2. Powell worked eight years for The Carlyle Group—a private equity firm. This gives Powell experience with hands-on private sector work, but also could cast him as “Wall Street.”
3. He is a Republican but appointed to the Fed by President Obama. Yet on Dec. 5 he was nearly unanimously recommended to the full Senate for approval by members of the Senate Banking Committee. (The only holdout was Sen. Elizabeth Warren, the Massachusetts Democrat, who expressed concerns that he would work with the Trump Administration to unravel the Dodd-Frank Act.)
4. Powell is a comparative rarity; he was working in finance and later studying major issues at a think tank during the creation and implementation of the Dodd-Frank Act. This gives him private-sector understanding of current regulation.
5. Powell has a strong relationship with Randal Quarles, the Fed’s new Vice-Chair for Banking Supervision. Powell and Quarles both worked at Treasury and The Carlyle Group.
6. In speeches, writings, and the Senate hearing Powell has given the following insights on his view of regulation:
a. Big banks need to have more capital; stress testing needs to continue and be better; and living wills are needed for all financial institutions posing systemic risk.
b. Smaller financial institutions should be subject to less regulation.
c. Regulation since 2008 is too complex and needs to be simplified.
d. Powell made it clear during the Senate confirmation hearing that he does not want the Fed to become embroiled in current controversies involving the Consumer Financial Protection Bureau.
What could be ahead
What could be the expectations of a Chairman Powell?
• Mortgage GSEs. Why did the Government Sponsored Enterprises not come up at the Senate hearing? Fannie Mae and Freddie Mac could be replaced with a private-sector approach. Powell, being a lawyer with private-sector experience, along with his relationship with Quarles and support from Secretary of the Treasury Steven Mnuchin, could help make this more likely. In a speech in July 2017, he termed the present status of the two GSEs as “unacceptable.” He called GSE reform “the great unfinished business of post-financial crisis reform.”
The mortgage banking industry, small banks and credit unions, and the home-buying public could really benefit from this because of the high inefficiencies of the GSEs.
• Future of regulation. Regulatory simplification would be high on Powell’s agenda, especially for smaller institutions. This was definitely mentioned by Republican senators at the Senate hearing and Powell did suggest his support. Senator Warren, who opposed his nomination, clearly sees him as likely to ease regulation. He told the committee that he felt bank regulation, overall, was “tough enough.”
This will reduce the increased burden of high regulatory expenses at the small financial institutions, which are far from a systemic risk to their markets or financial system.
• Regulatory tinkering. Powell will likely work to expand regulation in the sense of including a few more systemic risk financial institutions, better stress testing, and improved living wills. Navy FCU is the first to come to mind since Navy Fed is the market share leader in the Washington DC Core Based Statistical Area and is over $80 billion in assets.
• Monetary policy might continue with more rate rises. Lawyers tend to be less risky than economists, so rising rates may be less frequent with a Powell Fed.
Powell could shift to a supply-driven monetary approach instead of maintaining the focus on price to help small business borrowers and consumers who are still underwater in the mortgages on their homes.
Let me explain this a bit. Since 1947’s congressional mandate the Fed seeks to maintain both low inflation and low unemployment, the Fed has tried to do this for 70 years using the price of credit as its main lever. This is the opposite of what Milton Friedman found in his research, as described in A Monetary History of the United States From 1867-1960. Friedman showed a stable supply of money is much more important than manipulation of its price.
Such a shift would emphasize Main Street community banks and credit unions, which are the lenders to small businesses, which create jobs.
• No immediate plans for a “crash diet.” Quickly correcting the Fed’s $4 trillion bloated balance sheet may rank towards the bottom of Powell’s agenda initially. In the Senate hearing Powell said he views the Fed’s balance sheet shrinking to $2.5 trillion to $3 trillion, and this would occur over three or four years.
The balance sheet needs to be driven by currency and reserves, Powell said in the Senate hearing. This is classic Milton Friedman. More currency is needed even though electronic transactions are large and growing, the nominee stated. Reserves need to be higher to ensure greater bank liquidity, he also stated. It would appear Powell’s approach could be to let fiscal policy grow the economy, and then sell the Fed’s bond portfolio.
How to plan for a Powell Fed in 2018?
Here are some points to consider:
• Governor Quarles would be a key to watch on the bank supervision front. If banks examined by the Fed get less regulatory scrutiny this will be a signal to FDIC, OCC, and NCUA to do the same. The items of scrutiny to watch would come from the Dodd-Frank Act, which Powell knows well. Potentially less-costly examinations could lead to broader interpretation of compliance.
• Fewer rate increases as tax reform, if passed, produces economic growth.
• Retail and commercial mortgage lending could increase if Fannie and Freddie go to the private sector. This will take time but could be Powell’s secret weapon which would influence the housing market to begin to pick up in 2018.
With current Chair Yellen announcing she’s leaving in February, when her term expires, with the swearing-in of the new Chair, President Trump has four more nominations to make. The result will be a Fed board heavily dominated by Republicans.
Nominee Jay Powell will become Fed Chair and could become the first Fed Chair to drive the central bank “car” longer since Fed Chair William McChesney Martin (1951–1970). Under Powell the Fed’s car will be lighter with less regulation. There will be very little braking unless the economy goes south, and the accelerator will be used more if fiscal policy expands the economic highway.
(Mike will respond to questions at Mike@Moebs.com)