There's a huge difference between Janet Yellen and Trump's pick to succeed her - and it helps explain how he landed the job
- Fed nominee Jerome Powell appears to favor lighter-touch regulation of the financial sector.
- This probably endearing him to Donald Trump, who ran for president with chants of repealing the post-crisis Dodd-Frank reforms.
- Powell's statement that banks are no longer 'too big to fail' contradicts the view of many of his own fellow regulators - and Wall Street's own consensus.
- The country's three biggest banks together hold assets that amounts to more than one third the yearly output of the US economy.
- "No one knows how the next crisis will propagate through the financial system," says Sandeep Dahiya, a finance professor at Georgetown's McDonough School of Business.
We've been speculating for a while about what it is that Donald Trump sees in Jerome Powell, his nominee to replace Janet Yellen at the helm of the Federal Reserve (even though he's less qualified, not a trained economist, Yellen is doing a fine job, and recent practice is to not make a change like this in order to maintain some predictability at the Fed.)
What are some of those reasons? For one thing, Powell is a man. Also, he's a Republican. Also, even though Trump seems intent on undoing anything his predecessor did, Powell is seen as an extension of the current Fed's thinking and therefore a relatively safe bet sure to please record-setting stock markets.
But on Tuesday we got another explanation, and it is in fact not an extension of the Fed's thinking. Speaking in front of the Senate Banking Committee on Tuesday, Powell offered a sense of how his worldview aligns with Trump's.
Unlike Yellen, who has urged lawmakers to be cautious about revoking any post-crisis financial rules, Powell seemed just about ready to lobby on Wall Street's behalf.
"We will continue to consider appropriate ways to ease regulatory burdens while preserving core reforms," Powell, a former private equity executive said during his testimony. Trump has vowed to repeal the post-crisis Dodd-Frank financial rules.
Pressed by Democrats on why he saw bank regulations as a burden given the industry's record profits, Powell demurred. Senator Elizabeth Warren asked him what rules he would like to make more stringent, and Powell said none at all: "I think they are tough enough."
More strikingly, when asked by another senator if any of Wall Street's largest banks, which have only become bigger since the financial crisis of 2008, are still considered too large to be allowed to go under, Powell stated categorically: "No."
This view, which Powell had not previously expressed in public despite being a Fed governor since 2012, flies in the face of conventional wisdom, even among Wall Street firms themselves. It also contradicts the view of many of Powell's own colleagues at the Fed and other top regulators.
'Too big to fail' is not over
Kashkari is hardly alone. In May, Thomas Hoenig, vice-chairman of the Federal Deposit Insurance Corporation, another top bank regulator, told the Washington Examiner that "as much as we would like to conclude that too-big-to-fail has been solved, I don't believe it has."
Hoenig, former president of the Kansas City Fed cited "the commingling of very high-risk activities under the deposit insurance system, with the moral hazard that goes with that. You have these very large, complex, interconnected, undercapitalized institutions."
Yellen has been a bit more optimistic. She says the Fed has made progress in taming megabanks considered too gigantic to go belly up through higher capital requirements that force them to rely less heavily on debt, and through a new, as yet untested authority that supposedly allows the Fed to wind down a failing Wall Street firm.
But the current Fed chair, whose term ends in February, never made so bold a claim as to say the problem is fixed. And she has been emphatic about the need for short memories not to allow a repeat of the 2008 debacle, which coincided with the worst recession in generations - one that caused some 9 million jobs lost.
Powell's 'Mission Accomplished' moment
Just how big are the country's largest banks? JP Morgan held total assets of $2.5 trillion, Bank of America $2.2 trillion and Wells Fargo nearly $2 trillion. Together, that amounts to more than one third the yearly output of the US economy, which is by far the world's largest.
So why would Powell make such a bold claim?
Sandeep Dahiya, a finance professor at Georgetown's McDonough School of Business, describes it as perhaps a clumsy effort to bolster the Fed's own accomplishments.
"All big banks passed the Fed stress test in 2017, and all big banks are required to submit their 'living wills' that outline what should happen to them in case they fail," Dahiya told Business Insider.
However, Dahiya notes, the Fed has given extensions to the eight biggest US banks to get its approval for their living wills, so they are technically not yet fully compliant. That's if one even believes such blueprints for how to unwind a large institution would work in a chaotic time of crisis, which many finance experts do not.
That leads to the bigger issue.
"No one knows how the next crisis will propagate through the financial system -how realistic is the scenario that the US regulators will let three - or four or five - of the largest banks unwind based on their living wills," Dahiya said. "The spillover effects may be too severe and taxpayers may still have to put a backstop to the losses of the largest banks."
Even if we give Powell the benefit of the doubt of having made a mistake in tone, it's still an error that suggests a dangerous level of complacency about the need for vigilant bank regulation from one of its chief stewards.