In the wake of JP Morgan’s huge hedging losses, big banks are apparently worried about a new wave of financial regulation. And with good reason, says banking analyst Jaret Seiberg of Guggenheim Securities’ Washington Research Group:
– Discussions continue in Washington about legislation and/or regulations to break up the mega banks by forcing them to sell their broker dealers (Hoenig plan), requiring they separately capitalize outside the bank their non-lending units (ring fencing), lowering the asset or deposit caps, or boosting capital requirement on the mega banks even more than scheduled. The JP Morgan mess sparked these discussions.
– We believe it would take one more JP Morgan-like mess at a mega bank to turn this worry of congressional action into a real threat.
– Regulators could act even without another incident. That is why this week’s hearing is critical as there are new chiefs in charge of the OCC and the FDIC since we last debated breaking up the banks during the Dodd-Frank congressional hearings.
If the euro crisis worsens, it’s not difficult to imagine another situation emerging where a major financial player takes a big hit on a bad bet. So it is incorporating that political and financial context that I consider this new report from Citigroup, “Regulation and Growth: Insights from Extreme Case of Housing.”
Here is a summary (bold for emphasis):
– The regulation of credit through capital and other regulatory standards almost certainly has material impact on economic growth, even if that impact is poorly measured or commonly ignored in macroeconomic models. Policymakers and others might make important forecasting mistakes if they simply disregard it.
– How much impact the non-quantitative regulatory measures have is of course obscure, but in an attempt to quantify, we modeled the regulation of credit in the case of the U.S. housing boom and bust. In our results, we can see measurable impact from regulatory influence and believe it suggests wider influence even away from housing.
– In our model, mortgage and policy interest rates alone would have suggested a housing boom reaching less than 75% of the housing market sales peak in 2005. Mortgage rates in isolation would now suggest a current home sales pace 40% above current levels. But incorporating proxies for non-bank sources of credit and lending standards now suggests little growth in home sales from the present level, even if housing demand improves.
– Both Fed Chairman Bernanke and Greenspan argued that the housing bubble was not a direct function of easy monetary policy, instead citing a global saving glut. Aggregate U.S. growth and other measures of the policy stance in the 2000s give some support to that view. While blame can be shared all around, the very large boom and bust in housing appeared to be enabled by housing market regulatory policy, strong evidence that credit and regulatory policies can’t be ignored.
I found this to be a carefully worded and intentionally dense analysis. But this is my plain-English summary: Regulation can have a big impact on economic growth, for good or ill. Look at how housing policy juiced the housing market and led to the Great Financial Crisis. So let’s be careful here about new regulations on banks or, heaven forbid, busting them up. We repeat, let’s be careful of unintended consequences, Washington.
Not only does this report seem to mostly absolve the Fed for the financial crisis, but Wall Street, too. Here is what Citi means by bad housing policy: “For example, the Community Reinvestment Act was amended in 1992 so that government required Fannie Mae and Freddie Mac to direct 30% of their mortgage financing to borrowers who were at or below the median income in their communities. The quota was further raised to 50% by 2000, and 55% by 2007.”
I am not necessarily disagreeing with Citi’s analysis. I certainly would not disregard the role of housing policy in contributing to a classic bubble. But this economic report seems to be also serving a political function as well, attempting to shape the ongoing policy debate on Capitol Hill.