As expected, the U.S. Senate’s Banking Committee supported Janet Yellen to be the next chair of the Federal Reserve, opening up the nomination for a vote in the full senate. If there’s anything surprising about her ascendency, it’s the fact that her legacy as America’s central banker might be defined by the issue of too-big-to-fail as much as the end of quantitative easing (QE), the Fed’s current asset-purchase program.
If economists and business bloggers, myself included, rallied in Yellen’s support, it was because of her track-record on monetary policy. But perhaps we missed the point. As The Washington Post’s Ezra Klein first noted, the reason why Democrats in the Senate lobbied for her was a different one: They didn’t like Larry Summers, President Obama’s initial pick, because of his perceived coziness with the big banks. And it was very clear during Yellen’s Senate Banking committee hearing that Wall Street reforms loom large in the minds of both Democratic and Republican lawmakers — as large, and possibly larger, than QE,
There are two reasons for this. One is that some of the post-crisis efforts to overhaul the financial system, such as Congress’ massive Dodd-Frank bill of 2010, and the Basel III rules, crafted by global banking regulators, are finally starting to be implemented. Last week, Moody’s downgraded JP Morgan, Goldman Sachs and Morgan Stanley, among others, citing Washington’s new powers to force big banks into bankruptcy should their failure threaten the financial system. Instead of tapping into taxpayer money to prop up flailing financial giants, in other words, the government could wipe out shareholders — and Moody’s was putting big bank creditors on watch. There are a number of other important rules working their way through the financial sector, and others still that financial regulators, including the Fed, are still fine-tuning. The next couple of years will be, if you will, the first road test for some of the biggest finance fixes inspired by the meltdown of 2008-2009.
The other reason why Yellen will have to give big banks a whole lot of attention is that there seems to be new momentum in Washington to add new and deeper fixes. The notion that neither Dodd-Frank nor Basel III really solve the problem of too-big-to-fail enjoys some notable bipartisan support in Congress. As Shahien Nasiripour and Tom Braithwaite recount in the Financial Times, this has created some bizarre political marriages, such as that between Louisiana Republican Senator David Vitter and Ohio Democrat Sherrod Brown, who are pushing for a bill that imposes rules so stringent on the big banks it would likely force them to break themselves up.
Worries about the new rules could also forge unusual alliances at the Fed. “I can’t find anybody who argues that Dodd-Frank solves too big to fail,” Richard Fisher, president of the Federal Reserve Bank of Dallas and an über-hawk, told the FT. That’s not far from what Fed Governor Daniel Tarullo and Federal Reserve Bank of New York William Dudley, two well-known doves, believe.
Critics have argued that the new limits on how much debt big banks can take on compared to their assets are still too high. They also say these limits might be too complex, allowing banks to borrow more against safer assets, which opens the door to disquisitions about what constitutes a “safer” asset. Critics also contend that some banks are too complex for the government to be actually able to dismantle them quickly, should it need to. Another argument is that, for all the strongly-worded new rules about resolving failing banks into bankruptcy, regulators simply won’t have the guts to do so in reality. The only solution, then, would be to create strong incentives for the big banks to get smaller and never again grow that much.
In her first Congressional hearing as Fed Chair nominee, Yellen seemed to say that she wants to see how the current rules work out first. But she also told lawmakers she will keep an open mind on adopting further measures. Wall Street is watching with distinct apprehension.