Advocates of the stricter post-crisis financial reform had two reasons for encouragement this weekend, but skeptics still aren't ready to say that the problem of potential future bailouts is resolved.
First, General Electric Capital was released from the federal government's clutches. Having sold off a large chunk of its business, the firm no longer represents a threat to the financial system, the Financial Stability Oversight Council officially announced Wednesday.
On Thursday, congressional Democrats praised the move as a sign that the Council, created by the 2010 Dodd-Frank law to find financial threats to the financial system outside Wall Street, is having the intended effect, despite Republican criticism.
Big financial firms now "have a clear choice between stricter oversight or reducing their threat to taxpayers and financial stability," wrote Sen. Sherrod Brown, D-Ohio, and Rep. Maxine Waters, D.-Calif., the ranking members on the banking committees. The Council, they said in a joint statement, "is working just as Wall Street Reform intended: to protect working Americans from once again bailing out 'too-big-to fail' institutions."
Second, the Federal Reserve allowed all the big U.S. banks to pass the annual stress tests that gauge their safety in the face of a potential recession. Only one, Morgan Stanley, had any trouble passing the test.
The Fed noted that banks have effectively doubled their capital ratios since the bottom of the financial crisis, meaning that they are better positioned to suffer losses without risking defaulting on their obligations and sparking a crisis.
The banks and their industry groups hailed the results as a sign that the post-crisis rules that have tightened regulations on banks and boosted capital requirements are working — and that some forms of deregulation may be in order.
The good news is a turnaround from this spring, when regulators at the Fed and FDIC rejected the living wills of five megabanks, in effect saying that the banks are too big or too complex to fail safely under the bankruptcy code, and that the government would have to step in to resolve the banks safely in case of a crisis.
Critics of Wall Street, such as Massachusetts Democratic Sen. Elizabeth Warren, seized on the living wills results to argue that the big banks remain "too big to fail."
Some analysts also downplayed this week's results, arguing that they do not demonstrate that the financial sector is as panic-proofed as the administration and Fed would like to claim.
Anat Admati, a Stanford economist and author of The Bankers' New Clothes, said of the stress test results that "by some measures you can say there has been progress, but the benchmarks being used are problematic and I don't think that system is as resilient as we can expect it to be."
Admati has championed the idea of requiring banks to maintain high levels of equity, measured very broadly.
The stress tests measure banks' ability to maintain minimum capital levels by several different measurements, one of which is capital relative to assets weighted for riskiness, a gauge that some have argued banks are able to game. There is also a broader metric, a "leverage ratio" that simply measures capital against the bank's entire balance sheet, but at 4 percent it is much lower than many fans of the capital requirements approach to regulation favor. House Republicans, for example, have suggested a 10 percent leverage ratio.
As for General Electric Capital's de-designation as a "systemically important financial institution," some analysts worry about whether it redistributed risks to less transparent parts of the financial system when it downsized to avoid the added regulation.
Depending on where those sold-off assets land, said financial regulatory consultant Mayra Rodriguez Valladares, they could end up in a firm with less federal oversight. In that case, "are we really reducing risk in the system?" she asked.
Or, alternatively, the assets could go to one of the same big banks that regulators are trying to make safer, in effect making the biggest banks bigger.
That is the case with General Electric Capital, which sold an online banking unit to Goldman Sachs last summer. For the first time, Goldman Sachs will offer retail deposits through that bank.
Those deposits are insured by the Federal Deposit Insurance Corporation, noted Admati, meaning that federal taxpayers have a new source of exposure to losses at Goldman Sachs.
In thinking about the value of GE Capital effectively breaking itself up, Admati said, "I look more at the whole system and what's going on — whether the system's resilient. If it sells business to Goldman Sachs, are we better off? It's not so clear."