FED Chair says risk of financial crisis increases if Trump deregulates economy

From today’s LA Times by Jim Puzzanghera:

Federal Reserve Chairwoman Janet L. Yellen told senators Thursday that the risk of another financial crisis would increase if some Trump administration proposals to roll back regulations were enacted.

In her second straight day of Capitol Hill testimony, she walked back her statement last month that she didn’t expect another financial crisis “in our lifetimes.”

“I think we can never be confident there won’t be another financial crisis,” Yellen told members of the Senate Banking Committee.

The U.S. has “done a great deal” since the 2008 crisis to strengthen the financial system, she said. That includes forcing banks to hold more capital to cover potential losses as part of the 2010 Dodd-Frank financial regulatory overhaul law.

“It is important that we maintain the improvements that have been put in place that mitigate the risk and the potential damage,” Yellen said.

President Trump has promised to dismantle Dodd-Frank, which Republicans have said has been too burdensome for banks.

In a report last month ordered by Trump, Treasury Secretary Steven T. Mnuchin proposed sweeping regulatory reductions, including changes that would reduce capital requirements for the biggest banks.

Yellen said she would not favor reducing those capital requirements.

Read the entire article here.

Moody’s to downgrade large banks

FROM THE NYT DEAL BOOK BLOG:  If true, this is an important step by the market to correct for false advertising. One question is whether it will make a difference cleaning up corporate malfeasance and fraud.

Believing that the government is now more likely to let large banks fail in a crisis, Moody’s Investors Service threatened on Thursday to downgrade the credit ratings of several big financial firms.

If it follows through, Moody’s could reduce the ratings of Wall Street giants like Goldman SachsMorgan Stanley and JPMorgan Chase as much as two grades.

Such a move might weigh most heavily on Morgan Stanley because a two-notch downgrade would leave the company just above a junk credit rating. But the effects on the bank may also be muted. Confidence in large banks, judging by their stock prices and other financial indicators, appears to have risen since Moody’s cut their ratings last year.

Banks, more than other types of corporations, borrow huge sums of money to finance their activities. As a result, a lower credit rating can make it harder for them to find buyers for their debt, pushing up their borrowing costs. A lower rating can also deter trading partners from entering certain types of lucrative transactions with a bank.

Financial companies’ reliance on borrowed money is what made them so unstable in the 2008 financial crisis. The government has introduced measures, many of which are contained in the 2010 Dodd-Frank financial overhaul law, that are intended to put banks on a firmer financial footing.

Dodd-Frank also tries to set up a process for an orderly winding down of failing banks. Lawmakers wanted to avoid a repetition of the 2008 situation, where taxpayers were effectively forced to bail out banks to prevent their failure from hurting the wider economy.

The orderly wind-downs envisioned in Dodd-Frank could lead to big losses for creditors to banks. In recent months, regulators have started to flesh out how they might liquidate a collapsing bank. This progress prompted Moody’s to consider the downgrades now to reflect the lower possibility of government support.

“The conviction on this subject is clear, even growing,” David Fanger, a bank analyst at Moody’s, said. “This could lead to a one- or two-notch downgrade for some of these firms.”

Goldman, whose rating is A3, and JPMorgan Chase, whose rating is one notch higher at A2, declined to comment.

Many critics of the Dodd-Frank liquidation provisions doubt that the government would have the stomach to inflict losses on bank creditors in times of systemic stress. In April, Paul Volcker, a former chairman of the Federal Reserve, expressed skepticism about Dodd-Frank’s wind-down approach. “No one in the market believes it,” he said.

Still, Moody’s thinks the efforts have credibility, in part because regulators have started to describe the exact steps they might take in a liquidation. Under the plans, the government would seize the parent company of a bank and turn its debt into equity capital to make it stronger financially. In the process, regulators would most likely not seize the affected bank’s subsidiaries. That is why Moody’s on Thursday threatened to downgrade parent company ratings but not always those of bank subsidiaries.

Moody’s decision to review the ratings will reinforce the beliefs of those who say Dodd-Frank’s measures are sufficient to deal with the “too big to fail” issue. But the actions of lawmakers who do not feel the act is adequate may have also contributed to Moody’s actions. In recent months, lawmakers have introduced two bills that aim to do more to rein in large banks.

“They simply indicate the conviction within the United States government to solve the ‘too big to fail’ problem,” Mr. Fanger said. “They clearly put pressure on regulators to make the current law work.”

Mr. Fanger added that the Dodd-Frank liquidation process might lead to lower losses for creditors than a potentially less orderly approach. To reflect that possibility, any downgrades may be less severe, he said.

Citigroup and Bank of America, large banks that have relatively low ratings, may not have to worry about Moody’s latest action. The agency said their ratings had been placed on review “direction uncertain.” Moody’s perceives improved financial health at the two banks’ subsidiaries. That could offset the downward pressure on ratings from the Dodd-Frank liquidation process, Moody’s said.

S&P profits get bounce from inflating the ratings of bank investments

Here is an example of why American democracy and, by extension, the economy is irrational in real terms. Banks and financial institutions such as investment ratings agencies like Standard and Poor’s created a climate of perverse economic incentives in which they benefited from engaging in risky market transactions that led to the Great Recession. The numbers discussed in this story about how profitable S&P has become by providing (possibly) inflated ratings for investments that banks have undertaken are proof of two things:

1. We did not learn some important lessons from the Great Recession.

2. If we did learn those lessons, this knowledge has not translated into practice.

Why do we continue to allow banks and financial institutions to engage in such brazenly risky and short-sighted market behavior focused solely on profit maximization? Do we believe this kind of activity leads to innovation, job creation, and that “all boats will lift with the rising of the tide”? Doesn’t the Great Recession falsify this idealization that increased wealth means a better life for everyone?

The last recession was precipitated by the same large actors. Trillions were lost in assets. Millions lost their jobs. Why are we allowing this to happen again? Why do we tolerate a democratic process that permits the privatization of profit and the socialization of risk? Ask these questions, and read more about President Obama’s and Congress’s single biggest failure to address the problem of inequality in this country.—It’s the economy, stupid! We need to change it.

Read the story here.