Congruent financial regulation
The turmoil that roiled financial markets after the first COVID-19 lockdowns in March 2020 underscores the need to better coordinate regulation of economically similar financial activities, whether inside or outside the banking system, according to a paper discussed at the Brookings Papers on Economic Activity (BPEA) conference on March 25.
The paper—Congruent financial regulation by Andrew Metrick of Yale University and Daniel K. Tarullo of Harvard University—notes that banks last year proved to be a source of stability thanks to the more-rigorous standards enacted after the 2007-2009 financial crisis. But, they write, financial markets and less-regulated non-bank institutions (such as hedge funds, brokerage firms, and money market mutual funds) remain vulnerable in the United States’ patchwork regulatory system, so much so that at the start of the pandemic “the Federal Reserve felt it had no choice but to use its emergency powers to create an astonishing range of market-supporting measures.”
Non-bank financial institutions and associated funding markets “constitute a large and growing component of the global financial system,” the authors write. “But regulation has not kept up with this growth.” For instance, money market mutual fund participation in repo transactions (a form of short-term borrowing collateralized by Treasury securities) cleared through the lightly regulated Fixed Income Clearing Corporation has risen from nothing before 2017 to more than $250 billion in early 2020.
Congress appears unlikely to make regulation more consistent by consolidating financial regulatory agencies or by strengthening the authority of the Treasury-led Financial Stability Oversight Council (FSOC)—and both actions would raise significant policy issues in any case, they authors write. Thus, the agencies should collaboratively work toward an “overarching congruence principle.”
“Our proposed principle would be applied through imposing regulation based on the substantive nature of the intermediation. … It calls for regulation to be congruent, not necessarily identical,” they write.
The authors examine two case studies to illustrate the role played by non-bank financial institutions: the financing of non-prime mortgages (mortgages for borrowers with weak credit records) and the Treasury securities market at the start of the COVID pandemic. And they offer an example of how their congruence principle could work in the repo market. They would align bank-capital requirements with the rules for margining at clearinghouses and haircuts for bilateral repo transactions.
FSOC has 11 member-agencies, and the authors acknowledge that the “prospect of protracted inter-agency negotiations is hardly encouraging.” But, they conclude, “inter-agency processes in which the Treasury and Fed have the legal authority to take leadership is superior to the currently available alternatives.”
“You don’t have to have a kumbaya moment among all 11 FSOC members,” Metrick said in an interview with The Brookings Institution.
The authors write that the freezing of financial markets last March suggests there is “enough consensus to sustain momentum for a regulatory response.”
“I have more optimism now—not huge optimism—that something could get done than at any point in the past,” Metrick said.
Citation
Metrick, Andrew and Daniel K. Tarullo. 2021. “Congruent Financial Regulation.” BPEA Conference Draft, Spring.
Conflict of Interest Disclosure
The authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this paper. They are currently not officers, directors, or board members of any organization with an interest in this paper. Discussant Hyun Song Shin is an Economic Adviser and Head of Research at the Bank for International Settlements, which had the right to review his work.
A few small banks have become overdraft giants
The explosion of overdraft fees makes basic banking expensive for people living paycheck to paycheck. Banks and credit unions generate over $34 billion in overdraft fees annually by one estimate. What those with money experience as ‘free checking’ is quite expensive for those without. Prior research has focused on who pays overdraft, finding a small number of people (9%) are heavy overdrafters accounting for 80 percent of the fees. Not as carefully researched is whether this is just a small part of banks’ general business model, or whether for some banks overdraft has become their main source of profit. In fact a few small banks have become overdraft giants relying on overdraft fees as their main source of profit. These banks are really check cashers with a charter. Why do bank regulators tolerate this?
For six banks, overdraft revenues accounted for more than half their net income. Three had overdraft revenues greater than total net income (meaning they lost money on every other aspect of their business). First National Bank of Texas (doing business as First Convenience Bank) made over $100 million in overdraft fees yet posted an annual profit of just $36 million in 2020. Academy Bank and Woodforest National banks likewise made more money on overdraft revenues than profits in 2020. All three were entirely reliant on overdraft fees for any profit in 2019 as well. This is not a one-year blip; it is their business model. Armed Forces Bank, Arvest Bank, and Gate City Bank all rely on overdraft fees for more than half their profit.
Five of these six banks are national banks, regulated by the Office of the Comptroller of the Currency (OCC). Arvest Bank is a state-chartered institution whose primary federal regulator is the Federal Reserve (Saint Louis District), which seems to tolerate Arvest’s increasing reliance on overdraft as they went from 54 to 62 percent of total profit between 2019 and 2020. These regulators that allow banks to have a business model that depends on a single fee, charged only to consumers who run out of money, are not protecting the ‘safe, sound, and fair operation’ of the banking system.
It is disturbing that regulators tolerate banks that are mostly or entirely dependent on overdraft fees for profitability. Most of these are banks are regulated by the Office of the Comptroller of the Currency (OCC), but others are primarily federally regulated by the Federal Reserve and the FDIC has backup authority over all insured institutions. From a consumer protection stance, these entities operate more like check cashers and payday lenders than banks. From a safety and soundness proposition, reliance on this one highly costly fee is not sustainable. Don’t take my word for it: Oliver Wyman rang the alarm bell on overdrafts: “What should banks do about overdraft? We believe the crisis is accelerating the need to replace an antiquated product and an unsustainable value exchange.”
These are small banks, and most would be considered very small. Five had between $1 billion and $3 billion in assets (about one-hundredth the size of JPMorgan Chase). However, these banks may not even be the worst overdraft abusers. The smallest banks (those with assets totaling less than $1 billion) and most credit unions are not required to report their overdraft fee revenue at all. Researchers and consumer advocates have no idea how reliant they are on overdrafts. Unless bank regulators are asking these questions, the regulators may not know themselves. Regulators need to collect and publicize overdraft data for all banks and credit unions regardless of size.
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In principle, overdraft fees are intended to deter depositors from overdrawing their accounts. There is a customer benefit to not having your purchase declined at the cash register. However, overdrafts are incredibly expensive: $35 to cover a $25 purchase that is repaid in two days is equivalent to an annual percentage interest rate (APR) greater than 25 thousand percent. Granted, APR is not always a useful tool to compare products, but it is one most consumers are familiar with, and no actual loan on those terms would ever be permitted. This is why the decision to label overdraft as a fee instead of a loan—even though it is the extension of short-term, small dollar credit—has significant regulatory consequences. And it’s why it could be reversed by future regulators.
In practice, overdrafts are the business model for these six banks and maybe more. These entities are not really banks in the traditional sense of taking deposits, making loans, and helping customers and the economy. They are a combination of payday lenders and check cashers, whose business model depends on a single product with a sky-high annual interest rate that is only paid by people who run out of money.
Bank and credit union regulators need to crack down on these institutions that are operating in a neither safe nor sound manner. They should start by putting any institution for which overdraft is more than 50 percent of their total profit under strict consent decree. If the institution cannot change their business model then their ability to maintain their charter comes into serious question.
Regulators ought to reconsider whether the overdraft product is really a loan, not a fee. The Consumer Financial Protection Bureau should also engage. Lending money and then recouping it later, plus something extra, is economically a loan. Calling it a fee may exempt it from certain regulations, but it does not change its nature.
Finally, all banks and credit unions should be required to offer a basic, low-cost, no overdraft fee product. Bank On and the FDIC have both drafted requirements for these types of accounts. The American Bankers Association has called on all banks to offer them. Regulators and Congress should require it. This is a far more effective way to address the problem of the unbanked than other ideas, such as postal banking, because the main reason the unbanked cite for not having an account is cost, not branch location or hours.
Life before and especially during the pandemic forces those on the economic edge to make difficult financial choices with substantial health consequences. Now more than ever banks need to be a source of support for people, not fee generators. Banks reliant on overdrafts for their profits are no more than check cashers with a charter. Regulators are supposed to protect that charter; now, they need to act.
Government-sponsored enterprises at the crossroads
Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) play a foundational role in the U.S. housing market, providing financing to lenders for nearly half of current U.S. mortgages by buying the mortgages from lenders and packaging and selling them to investors. This makes mortgages cheaper and more available across the country.
During the housing boom of the 2000s and the crash in 2008, the GSEs were woefully undercapitalized. They were rescued by the federal government and placed into conservatorship with strict oversight by their regulator the Federal Housing Finance Agency (FHFA). Subsequently, multiple proposals emerged to restructure or replace the GSEs to reduce their risk of failure and advance the public mission that is the basis for their public support. While administrative reform of the GSEs has been ongoing since conservatorship began, in the past year FHFA has hastened the process of releasing them from conservatorship.
Any changes to the GSEs’ structure or operation will determine how well they are able to serve their public mission. These changes are taking place in the context of the current COVID crisis, a long lasting and broad affordable housing crisis, and a national reckoning on historic and ongoing racial discrimination. As discussed in this paper, several essential steps are necessary for the GSEs to best serve their important role.
Conservatorship has created an historic opportunity for addressing the nation’s affordable housing crisis and advancing racial equity in housing. As part of the assistance plan for the GSEs, the government received stock interests in the GSEs, now valued at $48 to $98 billion by the Congressional Budget Office. The value of these assets comes from fees collected from GSE loans and that value should remain in the housing market to further affordable housing. In particular, the government’s stock interests in the GSEs should be exchanged for a comparable commitment by the GSEs of additional affordable housing measures and a restorative justice housing program that provides targeted down payment and other assistance aimed at closing the racial homeownership gap.
While most home values and equity rebounded from the 2008 recession and withstood the COVID crisis, many families have struggled, particularly lower wealth families and families of color. A widespread affordable housing crisis limited opportunities for many across the country going into the COVID crisis, with homeownership far below pre-housing boom levels and more than 20 million families struggling with unaffordable rent. Conditions worsened in 2020.
A primary statutory purpose of the GSEs is to advance affordable housing. While the GSEs have maintained their affordable housing programs in recent years, conservatorship has constrained these activities. The GSEs have operated with limited capital at a time when the country needed substantially increased focus on and support of affordable housing from the GSEs. Now they must greatly increase their work to meet the country’s pressing affordable housing needs.
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The past year has also seen a national reckoning on the history and continuation of racial discrimination, exclusion, and segregation in our country. Systemic racial barriers exist in all facets of American life, including policing, healthcare, and housing. The housing market profoundly manifests these barriers, including in the huge gap between white homeownership, at 72%, and Black and Latino homeownership, at 42% and 48% respectively. This disparity is as great as that existing before the passage of the Fair Housing Act in 1968 and even going back to the 1890s. For the GSEs, only a small percentage of their home purchase loans have gone to Black and Latino homebuyers in recent years, with less than 5% of their loans made to Black families in 2019. The GSEs’ charters include a duty to advance fair lending and equity, and much more has to be done by them to advance that national responsibility.
The success of the GSEs in conservatorship – in which they have operated as de facto utilities and stabilized the housing market following the 2008 housing crash – establishes that utility oversight is the best structure for the GSEs going forward. During the COVID public health and economic crisis, a utility structure has enabled the GSEs to provide critical relief to the housing market and the overall economy – assistance that was possible only due to the GSEs’ special status, their substantial resources, and the enhanced oversight authority granted to FHFA under conservatorship. A utility structure should be implemented permanently in order to secure the GSEs as an emergency backstop during a crisis, enhance operation of the GSEs in regular times, and advance the GSEs’ public mission.
Increased affordable housing support, racial equity programs, and utility oversight should be solidified and formalized during conservatorship while the GSEs build up capital. It is critical for these reforms to be implemented before release of the GSEs occurs. While GSE reform can be implemented legislatively or by administrative action, enacting GSE legislation has proven difficult. Thus, continuing administrative reform is more likely. Central to the reform process is resolution of the GSEs’ obligations for the aid it received following the 2008 crisis and the ongoing backup support the government will continue to provide in the future. Any amendments to the documents governing these issues will lock in the terms of the GSEs’ operation and obligations going forward and will be difficult to change. Thus, bolstered affordable housing and racial equity measures and utility oversight must be baked into these steps.
Click here to download the full report.
Michael Calhoun is president of the Center for Responsible Lending. Lewis Ranieri is chairman and CEO of Ranieri Solutions LLC; co-chairman for the National Association of Home Builders Mortgage Roundtable since 1989; and board member of SolomonEdwards Group, Inc. since 2018. Other than the aforementioned, the authors did not receive financial support from any firm or person for this article or from any firm or person with a financial or political interest in this article. Other than the aforementioned, they are currently not an officer, director, or board member of any organization with an interest in this article.
Economic Impact Payments: Uses, payment methods, and costs to recipients
Executive Summary
When the COVID-19 crisis struck the United States in the spring of 2020, it posed a threat not only to the physical health of Americans but also to their financial health. The crisis found most Americans in financially vulnerable or coping positions, and many with incomes that barely made ends meet, high levels of debt, and low levels of savings that would not sustain them through the crisis. Recognizing that the social safety net in the U.S. would not be sufficient to support individuals and families through this crisis, several provisions of the Coronavirus Aid, Relief, and Economic Security (CARES) Act were intended to provide economic relief. Among these relief provisions were “Economic Impact Payments” (EIPs), direct payments to individuals and families broadly available to all of those making under specified income thresholds. As policymakers implemented these payments they ran into a number of challenges, such as identifying eligible recipients and distributing payments efficiently. In this report, the Financial Health Network draws upon publicly-available data and our own U.S. Financial Health Pulse to estimate how long recipients waited to receive their EIP, what fees some might have paid to access their EIP, and how recipients used their EIP. The report also compares EIPs under the CARES Act to the more recent round of $600 direct payments created by the Consolidated Appropriations Act enacted at the end of 2020. Our findings include the following:
One in 20 eligible recipients still had not received their CARES Act EIP after six months.
Only 45 percent of CARES Act EIPs were distributed in the first wave. Under the Consolidated Appropriations Act, 77 percent were distributed in the first wave.
It took almost four months to distribute 90 percent of CARES Act EIPs. Under the Consolidated Appropriations Act, it took less than three weeks.
One in 10 Americans received a paper check under the CARES Act, despite having a bank account.
Over three million paper checks from the CARES Act were cashed through check cashers.
A family of five could have paid $195 or more in check cashing fees in some states.
CARES Act EIP recipients paid an estimated $66 million in check cashing fees.
The most common uses of CARES Act EIPs were spending, housing, and bills.
The report concludes with recommendations for policymakers to ensure that future direct stimulus programs run more smoothly, as well as a brief discussion of financial infrastructure shortcomings and strengthening the social safety net.
Click here to download the full report.
Gian Maria Milesi-Ferretti
Gian Maria Milesi-Ferretti is a senior fellow in the Hutchins Center on Fiscal and Monetary Policy. He was previously Deputy Director in the Research Department of the International Monetary Fund (2014-21). In this role, he directed the department’s work on multilateral surveillance, including the World Economic Outlook, G-20 reports, spillover analysis, and economic modeling. Between 2012 and 2014 he was Deputy Director in the Western Hemisphere Department and IMF mission chief to the United States. He received his undergraduate degree in economics from Università di Roma La Sapienza in 1985 and his Ph.D. from Harvard in 1991. He joined the London School of Economics thereafter, and moved to the IMF in 1993.
He has published extensively in refereed journals in the areas of international capital flows, international financial integration, current account sustainability, capital controls, taxation and growth, and political economy. His paper “The External Wealth of Nations Mark II” (joint with Philip Lane) won the Bhagwati award as best paper published in the Journal of International Economics during 2007-2008. Since 1996 he is a Research Fellow of the London-based Center for Economic Policy Research (CEPR).
The future of blockchain and digital markets: A perspective from the World Economic Forum
On Thursday, February 11, the Center on Regulation and Markets at Brookings hosted Sheila Warren, head of data, blockchain and digital assets and member of the Executive Committee at the World Economic Forum, to talk about blockchain, digital currencies, and other recent developments in digital markets. Sanjay Patnaik, director of the Center on Regulation and Markets at Brookings, moderated the conversation.
Viewers submitted questions to events@brookings.edu or on Twitter using #FutureOfDigitalMarkets.
Climate change and financial market regulations: Insights from BlackRock CEO Larry Fink and former SEC Chair Mary Schapiro
There is growing interest among regulators around the world in helping to address climate change through the levers of financial market regulation. In addition, private companies are starting to elevate the importance of climate and sustainability risk for investment decisions. These developments are essential for influencing the behavior of market participants towards low-carbon investments and mitigating climate risks for companies and investors.
On Tuesday, February 2, the Center on Regulation and Markets at Brookings hosted Larry Fink, chairman and CEO of BlackRock, and Mary Schapiro, vice chair of global public policy at Bloomberg L.P., former chair of the Securities and Exchange Commission, and head of the Secretariat of the Task Force on Climate-related Financial Disclosures, for a discussion on climate change and financial market regulations. This event shed light on ideas and trends in this increasingly important area.
Viewers submitted questions to events@brookings.edu or via Twitter using #ClimateRegulation.