Is the Fed Chairman having pangs of conscience over regulation of TBTF banks? His latest remarks in Chicago indicate a willingness to implement tougher capital controls. The Fed’s much-ballyhooed stress tests of big banks were touted as assuring their survivability. Either the banks have taken on more risk since then, or the stress tests were rigged. Reporting on the Fed’s balance sheet expansion emphasizes how the Fed has bought impaired securities (MBS and such) from banks while extending them no-cost loans to buy long-dated Treasuries. We also know banks aren’t lending, with the exception of government-backed home mortgages and student loans. If bank risk has been reduced, then the stress tests were fixed. The Fed has used up all of its balance sheet tricks to keep banks solvent. Now banks are exposed to interest rate risk on their Treasuries. When rates inevitably rise, those Treasuries will drop in value and banks’ balance sheets will be crushed again. The Fed enticed banks to trade one risk for another.
More detailed reporting of the Chairman’s remarks reveals concern over a run on money-market funds. The financial crisis of 2008 almost achieved critical mass when money-market funds threatened to break below $1 of NAV. Nothing has changed and the money-market fund your bank says is as good as cash contains nothing more than IOUs from counterparties who can still go bust in a heartbeat. The best decision is to prohibit money market funds from owning anything other than cash but that won’t happen because the Fed would rather “assemble data on repos” as a fig leaf.
Maybe Helicopter Ben wants out when his term expires because he knows the Fed, owned by its member banks, will not tolerate any changes to money-market funds that reduce their usefulness as off-balance sheet funding tools. Tighter capital controls mean less lending but banks are hardly lending anyway without government backstops. The Chairman is having his moments of clarity long after the political will to force real changes on banks evaporated. The next crisis will be upon us with no advance notice. Federal Reserve officials concerned about their place in history won’t want to be around when it hits. “I’ll be gone, you’ll be gone.”