In early May of 2009, with the U.S. economy still losing hundreds of thousands of jobs a month, federal regulators announced the results of “stress tests” they had conducted on the country’s beleaguered big banks. After simulating what would happen to banks in the case of another financial crisis, government officials revealed that the institutions were close to healthy.
“With the clarity that today’s announcement will bring, we hope banks are going to get back to the business of banking,” Treasury Secretary Timothy Geithner said then, trying to close the book on the banking crisis.
Those first stress tests were conducted amid financial and economic turmoil, during the early months of a new Obama administration that would seek and enact historic and sweeping new regulations of the banking industry.
Eight years later, the circumstances facing the financial sector have undergone a nearly complete cycle. Stocks are at all-time highs, the unemployment rate is the lowest it has been since 2001, and home prices have mostly recovered. For the first time, all of the big banks that were tested cleared the stress tests, leading the banking industry to declare itself safe and call on the government to ease the burden of new regulations. The new Trump administration has set a goal of rolling back many of the new rules, and many of the factors it would need for success are in place.
Last month, the Treasury Department printed a report detailing a list of proposals for undoing parts of the 2010 Dodd-Frank financial reform law and other financial guardrails.
The agency called for the revision of some of the biggest features of the new banking regime, such as higher capital requirements, the Consumer Financial Protection Bureau, the Volcker Rule that limits banks from speculating with insured deposits, and the stress tests themselves.
The Trump administration has sympathetic Republican majorities in Congress. Even without legislation, though, the administration could bring about a major change in the overall attitude of government toward banking.
“I think it’s under-appreciated the extent to which the Treasury report already has been successful in terms of getting acceptance from the regulators,” said Phillip Swagel, a University of Maryland professor and former official in the Treasury Department under former President George W. Bush.
Indeed, a group of banking regulators, including Obama appointees, outlined some possibilities for regulatory relief at a Senate Banking hearing last month. The officials suggested that the time might be right to undo parts of the Volcker Rule and lift rules for many regional banks.
At a June news conference, Federal Reserve Chairwoman Janet Yellen appeared to be open to the idea that it is now time for a shift in the application of regulatory oversight. “We’ve done an awful lot of rule-writing over the last five or six years, and coming back and looking at where we’ve created burdens and ways in which we can simplify to reduce, that is an objective that is core to the Treasury review, and that we are very sympathetic with,” she said.
Some liberal senators have warned against using the improvement in the health of the banking system as a justification for backing off tight regulation. Sherrod Brown of Ohio, the ranking Democrat on the Banking Committee, said in a statement on the stress test results that “we should not scrap the rules because the banking system is less fragile than it was a few years ago — that’s how we know they’re working.”
The sense that the banking system is now safe could itself lead to increased risk in the financial sector, said Mayra Rodriguez Valladares, managing principal at MRV Associates, which provides regulatory consulting to banks. “My fear is that if right now in the coming months … we start to demand less from the big banks, that’s going to coincide right precisely with when credit starts to deteriorate,” she said.
Another reason not to draw a mandate for deregulation from the stress tests is that the examinations might not accurately reflect the strength and resilience of banks. On Wednesday the Americans for Financial Reform released an analysis suggesting that this year’s stress tests were “less stressful than ever,” on the basis that the simulated crisis did relatively little damage to banks’ balance sheets.
Alex Pollock, a scholar at the right-of-center R Street Institute who has studied financial cycles, cautioned that the U.S. will soon be overdue for a financial crisis and not to put too much faith into the stress test results. “If you believe stress tests can work, then you have to believe that regulators and central bankers really know what’s going on and what really is risky and what the future might bring. And nothing in financial history, especially the history of their pronouncements before the last crisis, gives you any faith that that can be,” Pollock said. “Nobody, including central bankers and regulators, knows what’s’ going to happen.”
In fact, the Obama-appointed leadership at the Federal Reserve, at least, remains resistant to the idea of accepting that the U.S. is now safe from another downturn.
Speaking last week at the International Monetary Fund in Washington, Federal Reserve Vice Chairman Stanley Fischer acknowledged that “there is no doubt the soundness and resilience of our financial system has improved since the 2007-09 crisis.”
Nevertheless, he added, “it would be foolish to think we have eliminated all risks.”
