Victoria Guida on Developments at the Federal Reserve and in Financial Regulation

The Fed had its hands full with personnel changes, Master Account discourse, and other major FinReg issues in 2022, and the next year is poised to be full of even more challenges.

Victoria Guida is an economics reporter for Politico where she covers monetary policy and financial regulatory policy. Victoria is also a returning guest to Macro Musings, and she rejoins the podcast to talk about the big developments at the Fed and in the financial regulatory policy space in 2022 and what we can expect in 2023. Specifically, David and Victoria discuss personnel changes and trading scandals at the Fed, the debate surrounding Fed Master Accounts, how to improve the liquidity of the Treasury market, and a lot more.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].

David Beckworth: Victoria, welcome back to the show.

Victoria Guida: Thanks for having me back.

Beckworth: It's great to have you on, you follow this closely and it's great to have you on to start the new year off, to look ahead at what may come at the Fed in the financial regulatory space. You have a really neat job. You get to cover the Fed. I get to see you every time there's a press conference. I see your face there in the audience of journalists at the... It’s at the Federal Reserve Building, right? Is it the new one?

Guida: Yeah. So, there used to be a nondescript building on K Street where we would do it, but the Martin Building, which was under construction for like five years is finally done. So now we're back there.

Beckworth: Yeah. Yeah. So it's great to see you there. And I know you also go to all the financial regulatory policy meetings that allow journalists in. Like you go to the FSOC meeting too, don't you?

Guida: Usually, yeah. Although, lately it's become a lot easier to just live stream it because it's not like you can grab them after the meeting and talk to them.

Beckworth: Okay. Okay.

Guida: But yes. I do go to the Treasury building for that too. It's in the Cash Room, that beautiful room I'm sure you're very familiar with.

Beckworth: Yeah, I was just in there in fact, visiting a friend at Treasury and he mentioned that FSOC meets in there and I was like, "Ah, this is where Victoria comes in to cover the meetings." So yeah, small world. But I'm glad to get you on Victoria because there's been a lot of exciting things happening. I think we can say 2022 was definitely an interesting year for the Fed and for financial regulatory policy. And I suspect 2023 won't be any less interesting going forward. So we've got a lot of ground to cover and we'll see where we get in an hour. But I want to begin with the Federal Reserve itself, the institution, it's people. And I just want to first note the personnel changes and maybe we can talk about that for a little bit.

Beckworth: So we got three new governors, Governor Lisa Cook, Philip Jefferson, Michael Barr. Michael Barr, of course, became the Vice Chair for Supervision. We also got a new Vice Chair for the Board of Governors, Lael Brainard, who was an existing governor. We also got several new Fed presidents. At the Boston Fed, we got Susan Collins, she replaced Eric Rosengren. At the Dallas Fed, Lorie Logan who replaced Robert Kaplan. Chicago Fed, Austan Goolsbee, who starts, I guess, this year, replaced Charlie Evans. And then soon to be someone replacing Esther George at the Kansas City Fed. So do these changes have any big impacts yet, or do you see them having impacts moving forward?

Overview of Fed Personnel Changes and the Fed Trading Scandal

Guida: Yeah, so they have a really big impact if you consider who's a voting member in 2023. So Dallas and Chicago both have rotated into voting positions for this year and obviously for the governors, they always vote. And one of the things that's been really interesting in this most recent fight against inflation is that there's been remarkably little dissent from anybody on the board. There's been a little bit in terms of Esther George dissented in terms of how fast she wanted to go because she wanted to stay at 50 basis point increases rather than the 75 basis point increases. But she actually wanted to go high in where they ultimately ended up with the terminal rate. And so that was sort of a minor difference where everybody is on the same page of wanting to get rates up really high.

One of the things that's been really interesting in this most recent fight against inflation is that there's been remarkably little dissent from anybody on the board.

Guida: And so, one of the things that's been sort of interesting is having these new governors, Lisa Cook, Phillip Jefferson, Michael Barr, who are President Biden's appointees, they haven't really particularly changed the direction. There had been some question as to whether someone like Lisa Cook who's focused a lot on workers, whether she might be a little bit more dovish. And what could be interesting is whether we do finally start to see that come out in the committee this year, because we're finally reaching a point where, when specifically does the Fed stop?

Beckworth: Yeah. So the unanimous support for these decisions may not be there this year going forward. And we might begin to see some cracks in that decision-making. So we have these three new governors. We have a number of new Fed presidents coming in. Now, a number of these Fed presidents came in because of these trading scandals that we had over the past few years. So for example, Susan Collins replacing Eric Rosengren, Lorie Logan replacing Robert Kaplan. So where does that stand now? Has that kind of died down or is there still some rumblings going on in the trading scandal?

Guida: So it's not officially over yet in terms of the investigation. So the Fed Inspector General, which is technically an independent agency, although an agency's relationships with their IG is always a little bit complicated, but the Fed IG is the one who's looking into this and they put out a very short report, it was like four pages, on Chair Powell and former Vice Chair Clarida, and basically said that neither of them had broken any rules. But what was kind of weird... there was nothing that required legal follow up, right?

Beckworth: Okay.

Guida: And what was kind of weird about that report was they didn't really go into detail on why. And there was sort of a hint in the report that said in terms of the investigation into Robert Kaplan and Eric Rosengren, that that's still ongoing. And it suggested that there might be some more detail on what rules were broken or weren't broken and why. So that report I think will be sort of important in terms of, let's say if Congress wants to have oversight of this situation, they'll see whether that report is sufficient. Because I do think that there is a possibility that if the IG report is too lenient, that might make some lawmakers nervous. Although this whole thing is very weird because I think Congress has a sort of, people in glass houses shouldn't throw stones-

Beckworth: Right. Right.

Guida: …Approach to this entire thing. And so it's led to this really weird situation where you have people like Elizabeth Warren who's been really harping on this and Sherrod Brown to a lesser extent. I mean, Warren's been sending letters constantly to the Fed. But a lot of other lawmakers, I think, are a little bit nervous about touching it just because they know that Congress sort of has its own issues on this front, on the trading front.

Beckworth: Yeah. And didn't the Fed, at least at the board level, introduce new regulations and guidelines that are very stringent, more stringent than Congress actually has now?

Guida: Yes. That helps too from the perspective of Congress saying, "Okay, maybe we don't need to step in," is they did put in a whole thing where, now top Fed officials can't do active trading, they have to get clearance... I can't remember off the top of my head. I think it's like 45 days ahead of time. And then they can only invest in broad-based funds. They can't buy individual stocks anymore. I should also mention, Raphael Bostic also had his own subsequent little scandal where he basically admitted to violating rules because he says he misunderstood the rules and it was basically like somebody was trading for him during blackout when Fed officials aren't even supposed to talk about Fed policy, let alone be making market moves. But he basically said that he thought that as long as he didn't know about it, that someone else could make those trades on his behalf. And he also exceeded the limit of how many treasuries they're allowed to own. So that is also still going on. So I think that they're sort of easing into this new ethics regime and the fact that Chair Powell acted so quickly... Well, I guess I can't say Chair Powell acted quickly because technically it was the officials that resigned, but one can assume that he had a hand in getting-

Beckworth: Right, behind the scenes.

Guida: … Them to resign, yeah.

Beckworth: Yeah, so it looks good, at least for PR value and making the first step, but to go all the way, we got to get the results of this investigation. And so is there any expectation of when it will come out this year?

Guida: No. And those reports are notoriously hard to predict. Whenever you check in with IGs in general, they're often like, "Oh, it's going to come this time." And then it gets pushed back. So it's unclear yet, but they've been working on it for a while, so I imagine it should come up out relatively soon.

Beckworth: But don't hold your breath because it may be a while longer. Let me go back to the Board of Governors and talk about some of the new people there. So I will mention Lisa Cook, she is a past guest of Macro Musings, so shout out to her. Also, I should say Lorie Logan's been a guest as well on the show. But I want to talk about Michael Barr as the Vice Chair for Supervision, very important role. And he seems to be more interested in Randal Quarles on looking at capital levels and possibly nudging it towards more capital levels. Am I reading him that he may be doing things a little more aggressively than the former Vice Chair for Supervision?

Guida: Yeah. So on capital levels, you mentioned Quarles… it's kind of interesting because when Quarles came in, he basically said the same thing, "We want to look at capital levels." But then Chair Powell, who was then just coming in as chair basically said, "I think capital levels are about right." And they sort of seemed to mutually agree on, that that was the way to approach the situation. So Quarles did loosen rules, but he tried to do it in a way that would neither raise nor lower capital. I think you're absolutely right that Michael Barr… he hasn't explicitly said that he's going to raise capital requirements, but he's basically done everything but do that. If you read between the lines on everything that he's said, he's laid the groundwork for why it would make sense to raise capital requirements. And he's also said that capital levels are strong, but he said, "Is it strong enough?" And so the question then is how specifically you achieve that because he said that he's looking at all capital rules in concert with each other and that he wants to get to a place where you're not just making tweaks to individual rules, that everything kind of makes sense and the overall capital requirements make sense.

Michael Barr...hasn't explicitly said that he's going to raise capital requirements, but he's basically done everything but do that. If you read between the lines on everything that he's said, he's laid the groundwork for why it would make sense to raise capital requirements.

Beckworth: Yeah, I got that holistic view he's taking, or review, I should say, he's taking of the capital requirements. And I recall from his speech, I guess last year, he mentioned he thought that the capital levels were at the low end of what most studies say is adequate. So there's room for improvement. So that will be interesting to see going forward, what happens there. What about Vice Chair Lael Brainard, any big changes she's bringing to that position?

Guida: So it's interesting because the Vice Chair, which I always think of as the Vice Chair for Monetary Policy, now that we have a Vice Chair for Supervision, but technically it's just the vice chair. So she's the number two in all things, technically. But she actually, before she was vice chair, was a key part of the monetary policy decision-making process. You may know that there's the troika at the Fed, which is the Chair, the Vice Chair and the New York Fed President and they're sort of like the central nexus of monetary policy decision-making. And so there was actually a time during the pandemic when Powell actually brought Brainard into the troika, so she became a… whatever a four-person thing is.

Beckworth: Right.

Guida: And so she now has a much larger platform as Vice Chair, but in a way it sort of made sense as sort of a continuation, because she's the PhD economist, whereas Powell is more of a lawyer, markets guy and so they sort of compliment each other. But I think she offers maybe more of the intellectual economics side of the monetary policy decision-making process

Beckworth: Kind of like her predecessor, Richard Clarida, he brings in kind of the intellectual arguments, for example, FAIT. He made these speeches, how FAIT is a form of temporary price level targeting. And she does the same thing, she brings the weight to bear. She also brings her experience working on FedNow, which is still kind of an ongoing project, which I think will be interesting to see what happens. And I appreciate her international perspective. She talks a lot, at least more than other governors, about the international role of the dollar, the effect that Fed policy is having globally. So it'll be interesting to see where that all lands. I want to talk briefly about Chris Waller, Governor Chris Waller as well. He's also relatively new, he's a Trump appointee and I want to bring him up because last year the Fed put out a proposal for a climate stress test for financial firms.

Beckworth: And what was interesting, this was in early December, is that Chris Waller actually objected to it. And let me just read his objection, which was interesting. I guess I recall Governor Brainard also objecting in the years past to the Fed's decision on countercyclical capital buffers. So it's not the first time a governor's objected on financial regulatory policy. I mean we don't see them objecting on monetary policy, but we do see something like this every so often. But I want to read what he said in this statement, when the Fed released their proposal. He said, "I cannot support this issuance of guidance on climate change. Climate change is real, but I disagree with the premise that it poses a serious risk to the safety and soundness of large banks and the financial stability of the US. The Federal Reserve conducts regular stress tests on large banks that impose extremely severe macroeconomic shocks and they show that the banks are resilient."  So I think what he's saying there is, "We've already got it covered. Why do we need to do an extra climate stress test on that?" Do you think this objection is important? Does it signal anything? Going back to what we talked about earlier, all of this support, this agreement, I mean, might this be another crack that's emerging at the Board of Governors at the Federal Reserve?

Dissent on the Board of Governors

Guida: Yeah, so that dissent was really interesting and as you mentioned, dissents are a bit more common on the regulatory side, although I would say that they've actually become more common in recent years. There were past regulatory dissents, I think Sarah Bloom Raskin when she was a governor, dissented. I think Betsy Duke when she was a governor, dissented on the financial regulatory side. So that's historically where within the board, that's where dissents have come. But you know, you mentioned Lael Brainard dissented a lot under Randy Quarles. And actually, you mentioned FedNow, Randy Quarles actually dissented on FedNow-

Beckworth: Oh, that's right.

Guida: In that vote. So we have seen an uptick in willingness to dissent on non-monetary policy issues within the board. And one of the things that I thought was really interesting about that... So if it would help, I could also sort of lay the groundwork a little bit on what's going on there. So yes, this is what's called Climate Scenario Analysis, which basically is sort of a piece of a stress test. So if you think about the way the stress tests work is the Fed says, "Okay, big banks, imagine this hypothetical severe downturn, these are the characteristics of the severe downturn. What would you do? What would happen to your capital levels?" And so then based on that, on how much their capital would go down, that actually goes into setting what their capital requirements are going forward. So there's a very, very specific sliver of that that's being used for the climate scenario analysis where it's basically, you would have scenarios, right?

Guida: Like let's say there were this level of wildfires, and it actually might even be more vague than that. Just kind of like, "Imagine that the temperature rises by this extent. What happens? What do you do?" And so I think that we are really, really, really early in this process. And the Fed has made clear that this is not going to affect their capital requirements at all, at least, yet. Just because what the Fed is really trying to do is gather information as to what kind of effect climate change might have on banks’ portfolios. But I think the way that it's set up is basically like, "Hey, just do what you can do. We want to figure out where the blind spots are, we want to figure out what data you have, we want to think about how you're thinking about this." And so Waller's dissent is really interesting because the Fed and other financial regulators have talked about this as an emerging risk, which is basically, it could be a financial stability risk down the road, but probably isn't right now.

Guida: So I'm not actually sure that a lot of financial regulators would necessarily disagree completely with Waller. But I guess part of the question is it all comes back to capital, which is if this is the start of a process to having specific capital requirements for lending to the fossil fuel industry, for example… the question would be, "Well, why not just make capital high enough so that regardless of what the tail risk is, the banks are protected." And so this comes back to Michael Barr's question of where should capital requirements be? And so this is all part of the question of the more you try and lower capital requirements and get them at the exact right level, the more the regulators are going to be inclined to come up with all these very complicated specific rules for outside situations. Whereas if you raise capital requirements a little higher, maybe you have a little bit more cushion for whatever happens, happens. And this is where I think Waller's point is, we already have stress tests for, they should be able to weather bad situations.

This is all part of the question of the more you try and lower capital requirements and get them at the exact right level, the more the regulators are going to be inclined to come up with all these very complicated specific rules for outside situations. Whereas if you raise capital requirements a little higher, maybe you have a little bit more cushion for whatever happens, happens. And this is where I think Waller's point is.

Guida: But the other point I would make is, it's interesting that Waller dissented but not Miki Bowman because she is on the regulatory committee and she was also a Trump appointee and she's sort of made clear that she's for a lighter touch of regulation. And so that indicated to me that there might be a lot of issues where, trying to wrangle a consensus on the board… the Biden appointees have a majority, but you could still have some tricky things with the Trump appointees because maybe they're coming at it from a different regulatory philosophy. And since the board does try and reach consensus, that's always a thing that gets taken into account.

Beckworth: Well I personally like the point you just made that the solution to all this is to have more capital or to fund with more capital, have a bigger buffer there. And that way you don't have to try to play God and figure out which risk is important, which risk isn't, what blind spots do we have? Just the easy, simple solution is to raise capital levels, but I know that's a hugely contentious issue by itself. So even though it may seem simple on paper and practice, I know politically, it's much tougher. One last thing about Governor Waller, I wonder going forward say should a Republican become the next president, might he be someone who gets appointed to be the next chair, I mean, under the Republican president? I mean I've heard someone bring his name up, he might be someone that a Republican president would appoint, have you heard anything like that?

Guida: Well, it really depends, right? Because if you think about what happened with Donald Trump, if you had a more traditional Republican president at that point, maybe they would've had Kevin Warsh or John Taylor as the Fed Chair rather than Jay Powell who was basically viewed as the Republican Janet Yellen on monetary policy. And so I think it sort of depends on what they're looking for, but certainly being on the board already makes it a lot easier to be chair. Both because they have a track record that you can look at. And because I think it's viewed as risky to appoint someone that hasn't previously been on the Fed, because markets don't necessarily know what to expect from them. And a lot of times what presidents want to avoid with appointing a Fed chair is they don't want markets to freak out because that doesn't look good for their presidency. And so I think that certainly he would be on the list. But like I said, it depends on the president's Federal Reserve philosophy.

Beckworth: Very interesting and we'll have to wait and see what happens moving forward after the next election cycle. Well let's move to another big development last year, which is probably still going to unfold this year and that's Fed Master Accounts. I know you've covered this extensively. Walk us through that story. I know it begins with at least public... I know it's going on before then, but publicly it really begins with Sarah Bloom Raskin when she was nominated to go to the Board of Governors. But walk us through the story and the roles that different senators have played in that story.

Being on the board already makes it a lot easier to be chair. Both because they have a track record that you can look at. And because I think it's viewed as risky to appoint someone that hasn't previously been on the Fed, because markets don't necessarily know what to expect from them.

The Fed Master Account Story

Guida: So Master Accounts are basically… if you're a bank or a credit union, you can deposit money directly at the Fed. That's why the Fed is a central bank because they're your bank. And so it's part of the payments process because people who have those accounts can transfer money directly to another account holder without having to go through anybody else. This is how banks transfer money to each other. And so the question is, who should be allowed to get those accounts? And it's interesting because there is at least some precedent for non-banks having accounts, but they appear to be very rare. So for example, Fannie Mae and Freddie Mac have accounts at the Fed, although they don't get to earn interest on those accounts, which is actually sort of a sidebar, a relevant point in monetary policy.

Guida: But anyway…. So, now that we have all these financial technology companies that are trying to do payments and maybe other aspects of banking, the question is, should they be able to get accounts too and be able to transfer money without having to go through another institution? And the reason why this matters politically is because Wyoming, they created this special purpose charter for banks that want to serve crypto companies. And there are a couple of banks out there, Custodia, which used to be called Avanti, but now they're Custodia, and Kraken, they've gotten these charters, but they're still sort of in a holding pattern because it's sort of unclear how they're going to be treated at the federal level, particularly by the Fed and whether they're going to get accounts.

Guida: And basically these institutions have said like, "Look, we've just been standing here in a holding pattern and waiting forever." Custodia has now officially sued the Fed over this. And so their senator, Cynthia Lummis who sits on the Senate Banking Committee has really picked up this flag and been arguing for more transparency, more rules around… you have to act within a certain period of time, that sort of thing. And this relates to Sarah Bloom Raskin because there was this FinTech called Reserve Trust that advertised on its website that it had a Master Account and it was a state-chartered trust, which is sort of a version of a bank, but it's... Basically, I'm not aware of other state-charter trusts that have an account at the Fed. And so, the Republicans were always sort of vague... I say the Republicans, because Pat Toomey picked up this issue as well.

Guida: They were always a little bit vague as to what they were alleging happened because they were basically like, "Well, there was a phone call between Sarah Bloom Raskin who used to sit on the Fed and Esther George." Or I guess it was the Kansas City Fed, I don't know whether specifically it was with Esther George. And after that their account got approved after initially being denied. And then the question is, "Well was that because they changed their business model, blah, blah, blah, blah." So the Republicans were holding up Sarah Bloom Raskin's nomination until they got more information on this. And then ultimately, it became a moot point when Joe Manchin came out against her. But it's really drawn attention to the fact that we don't actually know who has Master Accounts. And the question is, why? Why shouldn't we know that? And I think the Fed has heard that complaint and they have now proposed disclosing the list of everybody who has an account.

Guida: And actually, I think in some cases it probably would make their lives easier rather than having to just stonewall lawmakers. Because, I mean, this is part of the reason why Senator Toomey was so upset is he was asking what seemed fairly basic questions on, why did Reserve Trust get this account? Why did they then lose their account, which is a part I didn't even mention. This happened after the Sarah Bloom Raskin saga, we found out that they then lost their account. And basically the Fed is like, "We can't talk about individual situations." And that just seems like not a great situation to be in. So they're now working on standardizing the process, coming up with more guidelines, but even under the new guidelines, the Fed would still have a lot of discretion as to who gets accounts and who doesn't.

We don't actually know who has Master Accounts. And the question is, why? Why shouldn't we know that? And I think the Fed has heard that complaint and they have now proposed disclosing the list of everybody who has an account. And actually, I think in some cases it probably would make their lives easier rather than having to just stonewall lawmakers.

Beckworth: Yeah, let me ask a question about who actually makes this decision. So all the heat surrounding the Wyoming FinTech companies was related to the Kansas City Fed and Esther George. So does she make it or does a regional Fed Bank determine if the particular company is in their district, do they determine, or does it get determined in DC by the Board of Governors?

Guida: No, so every single reserve bank, it's up to their discretion who they give an account because when we say that these banks have accounts at the Fed, they have an account at a reserve bank. And so each reserve bank... I mean, this is part of why it's a little weird because those standards might be completely different depending on which reserve bank you're going to. And actually I think another reason why this situation had a particular political salience is, the Kansas City Fed is also the Reserve Bank that is over Wyoming. So it's like, they gave the account to Reserve Trust, but they haven't acted on these Wyoming institutions. But I mean, it's funny because I think what the Fed doesn't want to say and probably still wouldn't say, is they're still kind of trying to figure out what they think about crypto. And I think that's really what's behind all of us. I think that's why they're just kind of waiting. But they would never say that, especially now that they're in the middle of a lawsuit, they're not going to-

Beckworth: Right. Right.

Guida: They're not going to say anything that legally suggests that they're going to be treating institutions differently. But that's sort of my educated hunch, I guess.

Beckworth: Yeah. And we'll come later to some of the proposals that Senator Toomey made. Now these died with the Congress last year, but one of the things he proposed was making these regional Fed banks more accountable to Congress. And we'll talk about that in a minute. But I will note that Senator Toomey proudly declared that in the annual defense bill, he got a part of the bill to require Federal Reserves to have transparency with the Master Accounts. So I'm going to read an announcement that he made, his office made. "US Senate Banking Committee ranking member Pat Toomey released the following statement after his provision requiring the Federal Reserve to provide transparency to the public about Master Accounts was included in the National Defense Authorization Act. ‘Events and information gleaned over the last year have raised significant policy questions about the Fed's approach to awarding Master Accounts.’

Beckworth: ‘Access to the Fed's payment system is a highly valuable public good and Congress has a responsibility to taxpayers to ensure regulators give out public goods in a fair and consistent manner. This provision will provide the American people with the information about Master Accounts, applications they deserve, but which the Fed has refused to provide. The Fed and other regulators need to know that if they won't be transparent, Congress will hold them accountable.’" So this provision will require the Fed to actually disclose who has it and also who's applied for it in the past. And apparently they have like 120 days to comply after this became law. So that will be interesting to follow as well and see what this means. So you've mentioned the Fed is maybe hesitant because they're in a lawsuit, they're also wondering about crypto and the implications for policy there. And this part of the omnibus bill is going to require them to move relatively soon.

Guida: Yeah. So that's disclosing who has them and who's applied, which I think the fact that... I'm not positive, but I think the fact that it requires them to disclose who's applied actually goes beyond what the Fed has proposed recently. But the Fed, like I said, proposed to disclose, periodically, who has one. And so given that that law passed, you'll probably see a finalization of that proposal pretty soon in line with what the law said. And basically it's like, "Okay, Fed, you have said that you're going to do this out of the goodness of your heart, but we want a guarantee." And I'm sure there's also… speaking of legal considerations, it's probably also useful because you could imagine someone with an account potentially suggesting that it's a confidentiality problem that the Fed is doing this. I haven't heard anyone make that argument, but that does sort of protect the Fed a little bit more from that kind of challenge.

Beckworth: That's a good point. Now the Fed also disclosed some guidelines for how these accounts would be appropriated and assigned. They had these three levels, three tiers of institutions. And this came out, was it September or late last year sometime, right? That they released this after some discussion and I had George Selgin on the show and he was not impressed, he was underwhelmed to say the least. Because he thought that the last tier, which is where these FinTechs would fall, is still relatively vague. It still doesn't give specific timelines. Like, you have a decision will be made within a certain amount of time. And so I guess the question then is, have we really resolved the key underlying issue, which is, how do these Master Accounts get assigned and are they assigned consistently across the regional Fed banks? So I guess that's still an open question, is that right?

Guida: That is still an open question. I think that part of the point of those guidelines was really more a matter of consistency, because as I said, every reserve bank... It's still up to every reserve bank. It's up to their discretion, which is, I think, part of the reason why it is so vague because they're trying to preserve a little bit of that. But it's basically trying to make sure that there are some basic standards that apply across all 12 of the reserve banks.

Beckworth: Alright. Well, let's move on to another area where the Fed's taking some heat. We've been talking about areas where the Fed’s been taking heat, trading scandal, Fed Master Accounts. Let's move to Fed policy itself. And we're not going to spend time today talking about monetary policy itself, what it should do, where it should go, but the critique it's got from Congress. In particular, it's got a lot of heat from Democratic members of Congress. You mentioned Elizabeth Warren, Sherrod Brown, both senators and others as well. And increasingly it seems like they're worried about what the Fed is doing. Do you see this continuing to be a problem in 2023?

Fed Policy Critiques in 2023

Guida: Yeah, I mean, like always, how people react to the Fed will depend a lot on the results of what's happening, right? And so I think that part of what has shielded the Fed a lot is the fact that the labor market is still so strong. And so if you start to have a situation where you see unemployment going up a lot, then you're going to probably see people get more vocal. As you've said, Elizabeth Warren is one of the lawmakers that's been really vocal the longest. You did see some wording from Sherrod Brown, from Maxine Waters saying, "Hey, you better watch out because you made these commitments to workers that you were going to care about them." And what's interesting about those statements though is there was sort of a crescendo right before the midterm elections. And so I am curious whether there was putting down a marker in case... this isn't to say the Democrats don't actually care about workers. Of course, they do.

How people react to the Fed will depend a lot on the results of what's happening, right? And so I think that part of what has shielded the Fed a lot is the fact that the labor market is still so strong. And so if you start to have a situation where you see unemployment going up a lot, then you're going to probably see people get more vocal.

Guida: But I think that maybe if they had done poorly, you could maybe shift a little bit of blame to the Fed and say, "They've been hammering workers, there's inflation that got out of the bag and then now they're punishing some of the most vulnerable." And so I will be interested to see how that messaging plays out. But I think for now, like I said, it depends on, do we go into a recession, what happens with the job market? Because if the Fed really does pull off a soft landing, then what you're going to hear from a lot of Democrats is probably going to be more muted. And the fact that we have a divided Congress is also interesting because Republicans… even though they've been harping on inflation, they want to blame President Biden and government spending for that. And so they've been a little hands off on the Fed for that reason.

Beckworth: So what do you think republicans will be doing in Congress this year? What will be their main issues going at the Fed?

Guida: It's not necessarily monetary policy, right? A lot of the things that they complain about are the woke Fed, like we mentioned climate change earlier, and ESG and things sort of in that direction. I mean, if you do see the Fed back off... I guess the Fed is presumably going to stop raising rates sometime here in the next few months. We’ll see, and if inflation still remains high, you might see some grumbling from Republicans. But again, inflation is something that they like to use to hit the Democrats right now. And so, I think it'll largely be non-monetary policy issues, particularly we were talking about Michael Barr raising capital requirements. That'll be probably a big area of focus.

Beckworth: It'll be interesting to see a Republican Congress and a Democratic Senate oversight on the Fed with different visions of what they want. Well, speaking of Republicans, I want to circle back to Senator Toomey. We've mentioned him several times and he was really busy near the end of this past year. I mean, I can't count how many proposals he had and they're very interesting ones. I really enjoyed seeing everything he put out and I want to read a few of them. Now, these have died with the 117th Congress, but maybe some Republicans will resurrect them, maybe not. We'll find out. But I think they're worth going over just to see where the interest is and also where Republicans may go, you touched on some of this already.

Beckworth: I want to touch first on one called the Financial Regulators Transparency Act. And this was both endorsed or proposed by him and Senator Elizabeth Warren. And this, “would strengthen the Federal Reserve accountability and ensure that no financial regulator can withhold critical ethics related information from Congress. The bill would subject the regional Federal Reserve banks to the Freedom of Information Act and ensure their responsive enough to congressional information and request.” So Senator Warren, Senator Toomey both want this for different reasons. Do you see this being something that gets resurrected in the 118th Congress?

The Financial Regulators Transparency Act

Guida: So it could. I think that it probably would be tweaked. I think that the banks probably have some concerns with whether some level of confidential supervisory information might be divulged that they think is not a good idea. And also, you've heard some complaints from people who are sympathetic to the Fed that this goes beyond what other institutions are subject to in FOIA. But I mean the general notion that the reserve banks should be subject to FOIA, I mean, I'm a journalist so I'm biased, but seems pretty reasonable to me. And the fact that you had Elizabeth Warren and Pat Toomey who are obviously very, very different in their political views, signals that it could have some real legs. But the issue is, I think Warren and Toomey pay a lot more attention to the Fed than most other lawmakers. And so the question is not only how appealing it is to people, but also whether it gets put on the agenda. And this is something that Toomey did, you know, you mentioned the Master Account thing that made it into law. Toomey was willing to make the Fed a priority in terms of, you might remember... I can't even remember when that was, at the end of 2020, with the emergency facilities, the 13(3) facilities.

Beckworth: Oh, yeah.

Guida: Toomey was holding up the end of your bill because he wanted to have language in there about how those needed to stop. And so he was willing to have skin in the game and get that through. And so the question is whether you have someone on the Republican side who comes at those issues with the same sort of fervor, which there may well be. Although I think that Toomey also… He had his particular opinions. It wasn't necessarily like the Republican opinion. It was like… Toomey had things that he cared about.

The general notion that the reserve banks should be subject to FOIA, I mean, I'm a journalist so I'm biased, but seems pretty reasonable to me. And the fact that you had Elizabeth Warren and Pat Toomey who are obviously very, very different in their political views, signals that it could have some real legs.

Beckworth: So what you're saying is we may not have another Republican who cares as much as he does about these issues and they need to all get on board to make it happen. And just to be clear, Elizabeth Warren was pushing this because she was concerned about the trading scandal, right? Whereas Senator Toomey was more worried about the woke research and efforts coming out of the regional banks. Were there other issues they were going at as well besides those?

Guida: Yeah, and I think the Master Account issue that we mentioned earlier was also-

Beckworth: Okay, Master Account.

Guida: …Toomey's issue because he was trying to get information out of the Kansas City Fed and didn't get really anything.

Beckworth: So Master Account and then the woke research efforts. Well let's move on to another proposal he had. And this one is probably the most fascinating one and one that would really shake up the Fed. And again, this is no longer in play because it's a new Congress, but this is the Federal Reserve Accountability Act. Let me read from his proposal. "US Senate Banking Committee ranking member Pat Toomey today introduced the Federal Reserve Accountability Act to increase accountability, address left-leaning political activism, and ensure greater geographic and professional diversity within the Federal Reserve system." And there were a number of co-sponsors, I won't read all their names, but here are the key bullet points. "What would this proposed bill do? First, it would increase accountability by making the presidents of the Fed regional banks presidentially appointed." So they'd have to be appointed by the president, confirmed by the Senate.

Beckworth: "It would also make the general counsel a presidential appointment. Second, it would reduce the number of Fed regional banks from 12 to five." So that would be a big change. And I imagine that would be a very contentious decision. Even if you could pass that in law, the process of narrowing down from 12 to five… I mean, if you read the history of how they actually came up with the 12 in the first place, it is very political, which state got it, which state didn't. So that would be a huge change, but it would be an interesting one. And then they would apply an anti-lobbying act to Fed regional banks so that they couldn't lobby Congress and then they would really enforce the geographic diversity requirements. So the big things there, I guess, would be narrowing down the regional banks from 12 to five and they would all be presidential appointees, Senate confirmed. Any thoughts on that bill?

The Federal Reserve Accountability Act

Guida: Yeah. So I don't think that will happen, but a couple of points. Well, the reason why I don't think that it will happen is because changing the structure of the Fed is something that kind of everybody wants to do, but no one agrees on how. And so if you were to do any type of change to the Fed structure, it would open up a can of worms and people would be like, "Well if you're going to do that, I want to do this." And I think that people don't really want to go down that path. I mean, because as you were saying, where the 12 cities feels a little random, the fact that there's Kansas City, and St. Louis, it's basically because the speaker of the house at the time was from St. Louis. So, there are ways that you could make the Fed make more sense and actually people within the Fed would probably say the same thing. But I think that once you open that door, it's a little bit hard to close it. And so absent some sort of really big crisis, you're unlikely to see that. And you think about… so for example, Dodd-Frank, which actually ultimately expanded the powers of the Fed. But you also saw some curtailing of, for example, their emergency lending powers. And I think that you tend to see big changes like that following some sort of big crisis event. And I don't think that there's really an action forcing event.

Guida: But the reason why I think bills like that still matter is, it's an implicit threat to the Fed. And even though those bills are not going to become law, it's not very difficult to threaten the Fed through legislation because they know that Congress can ultimately do anything they want to them through legislation if they got angry enough, right? And so the Fed, I think, legislatively, tends to think many steps ahead. And so they know that if they're making people mad on both sides of the aisle, then that increases the odds that bills are going to pass that do things to them that they don't like. And so I think that this is sort of putting down a marker by Republicans of like, "This is the stuff that we're mad at you about and we're watching and we're thinking about, maybe this thing that you like, we want to take away from you." So that's the reason why I think legislation like that still matters, even though I don't think it will actually pass.

Beckworth: So it's a warning shot fired across the bow of the Fed. "We're watching you, be careful." Yeah. Okay, well let's move on from Senator Toomey. And I would encourage listeners to go check out all the many things he proposed last year. We'll provide a link to that. Let's move on to other developments in the financial regulatory space in the time we have left. So we talked earlier about your job where you cover FSOC, so anything happen interested on FSOC this past year?

The reason why I think bills like that still matter is, it's an implicit threat to the Fed. And even though those bills are not going to become law, it's not very difficult to threaten the Fed through legislation because they know that Congress can ultimately do anything they want to them through legislation if they got angry enough.

The FSOC Focus in 2022

Guida: So FSOC ended up focusing on a lot of crypto type stuff this year. Stablecoins were the big area of focus there. And it's kind of interesting because this whole crypto meltdown, which was really exacerbated by FTX, but one of the first pieces was sort of the Terra, Luna collapse, which was related to stablecoins. And FSOC has been looking at whether it's possible that a stablecoin could pose a financial stability issue. And it's interesting actually because their whole theory of the case was basically that you could have a stablecoin that would become a private method of payment. And I think they were thinking about the Facebook project, Libra, which then became Diem. And ultimately that didn't happen, and that's because Treasury and the Fed told them no. But now you have a situation where a lot of the concerns in the crypto space are sort of more general market issues as opposed to payment issues. So that's sort of a theoretical issue still.

Guida: The other thing is, at the end of last year was the first time that FSOC identified climate change as an emerging risk to financial stability. And so they set up these internal committees and they've basically been just looking at a lot of data, right? Which, a lot of the climate stuff is, I don't know, it's kind of boring right now to talk about because the regulators, as I said a little bit earlier, they still don't really know what the fallout of climate change could be on financial markets. So they're just sort of collecting data. It's interesting too because I think that FSOC has also been looking at partnering with NOAA for weather pattern data and things like that, but that's been a big area of focus. And then they've also been looking at the Treasury market, Treasury market reforms. You've seen some proposals out of the SEC. We can get into that if you want to, to try and make it so that when you have these episodes of stress, it doesn't affect the Treasury market quite as much. But that's sort of an ongoing project.

Beckworth: And maybe we should have mentioned from the get-go, but FSOC, what does it stand for?

Guida: It's the Financial Stability Oversight Council. And their whole purpose is basically to be a convener of all of the different financial regulators. It's chaired by the Treasury Secretary and also to potentially, put regulation on institutions that are maybe falling through the cracks that don't fall neatly into one agency's jurisdiction or another.

Beckworth: Yeah. And I would encourage listeners to go back to the first time I had Victoria on. We spent a lot of time talking about FSOC in great detail. So you go back there, you'll know everything you need to know about FSOC. But one of the big issues surrounding FSOC when we discussed it back then, and I've had some other guests who came on, was that FSOC under Trump really didn't have any teeth or it kind of let things slide. And the hope was under Biden, under Secretary Yellen, it would really get its stride back and begin to label more systematically important institutions as a threat and therefore have higher requirements. Is it doing that? Is it going back in that direction more?

Guida: So not yet. As you sort of indicated, FSOC has the power to designate institutions as systemically important. And so, the institutions that they designated under the Obama administration were AIG, MetLife, Prudential, GE Capital. There's also other systemically important financial market utilities, but we won't get into that. And so this was a response, obviously, to the financial crisis where you had institutions like AIG that were so interconnected with the rest of the financial system, they had these credit default swaps for mortgage backed securities and all sorts of other securities that then started blowing up and everything was on AIG. And AIG was not properly regulated, was basically the lesson that was taken away from that. And then now there are no institutions that are currently designated as systemically important, and they got out in a series of ways. GE Capital basically gave away a lot of its financial services arm. MetLife sued and won, and then in the middle of the appeal, the Trump administration took over and then dropped the appeal. So that ruling stands.

Guida: And then AIG and Prudential were both de-designated under the Trump administration. And what was interesting about that is AIG had considerably shrunk itself. I mean, it had actually already started to shrink itself by the time it was designated, but it had arguably shrunk more. Whereas Prudential didn't really do much change at all because they basically were like, "Well, we're designated as systemically important. I guess this is our lives now." And to be clear, what happens when you're designated as systemically important is that you're put under the supervision of the Fed. So I mentioned that MetLife case, that because it still stands, that has huge restrictions on due process and things that they said that FSOC didn't do. If that whole appeals process had gone through, we might be looking at a slightly different situation. But for now, FSOC is bound by that lawsuit.

Guida: And so Yellen, who is the head of FSOC and regulators have sort of indicated that they want to look at changing what happened under Trump. Not only did they de-designate these institutions, but they also said, "Look, why are we even looking at individual institutions anyway? Let's just look at activities that might pose a risk." And so there is active discussion right now in FSOC about changing the approach a little bit back, but as I said, that MetLife case might make it a little bit more complicated as to what the final result actually looks like. And it might not look the same as it looked before.

Beckworth: I mean, we're two years into the Biden administration, so they don't have a lot of time left. I mean they have two years to get this change. But you're saying the focus is going from individual entities to broader activity focus, which is probably a safer way to do it if it does go back to the courts. Well, let's move on to another area you touched on, and that is Treasury liquidity. So we have a few minutes left and you mentioned FSOC got into that, and this is something I've been following too. I've had a number of guests on, and there's been a number of proposed changes, to regulation, to laws that would improve the liquidity of the Treasury market. And one of them really is tied closely to the Fed, and that's a supplemental leverage ratio.

Beckworth: So this is something that they relaxed during the pandemic. So what it requires is for all these assets that you hold, you've got to have so much capital. And this includes the reserves, the bank reserves they hold. And so the Fed released that requirement during the pandemic temporarily, it was a temporary relaxation and now it's back in play. But there's been a lot of talk, and in my understanding, there's been discussion at the Fed of making that permanent or tweaking it in some manner. So could you walk us through that?

Improving the Liquidity of the Treasury Market

Guida: Yeah, so to explain the issue broadly, so there are risk-based capital requirements and there are leverage ratios. Risk-based capital requirements say, the specific cap capital requirement for an asset depends on how risky it is. Leverage ratio says, every asset's treated the same in case we screw up and we're wrong about our risk weightings. And so every asset is included in that, which includes treasuries and as you said, reserves, deposits at the Fed, which are pretty much the safest thing in the world. And so during the pandemic, what happened was… so the way that the Treasury market is structured is that large dealers, particularly big banks, basically have to sit in the middle of trades, of the vast majority of trades. And so because treasuries have to go through their books, there are capital implications if every time they have treasuries on their books, it has capital implications.

Guida: And so what happened was, the argument was that big banks were not doing as much facilitating of trades in the Treasury market because they were worried about the capital implications of doing that. And so as you mentioned, they temporarily exempted... The regulators temporarily exempted treasuries and cash and bank reserves from the leverage ratio. And the reason they also exempted reserves is because there's this whole thing where the regulators don't want to make… force banks to favor one over the other. So they want to treat them the same because for regulatory purposes, they view them as being equally good and it can have monetary policy issues if banks favor one over the other. But anyway, so that was temporary. Not a lot of banks really took that much advantage of it. And the argument I think was just that because it was temporary, banks were like, "Well, we know it's going to end, so we're not really going to change our behavior very much."

Guida: And so the question is what happens now? Because this could still be an issue where the next time we have stress in the Treasury market, if we have banks sitting on the sidelines, that's not great. And so there are a lot of different ways to deal with this. One of the proposals is to change the structure of the Treasury market, so fewer trades have to go through banks. And so the bank's capital requirements would matter a lot less to the functioning of the Treasury market. And then it's also interesting, because this is, I guess, more in the weeds. But banks have a ton of different capital requirements, and so what always kind of matters is what's binding, so the highest capital requirement for any given asset. And so I think for certain institutions, the supplementary leverage ratio is more binding than for others. And so you could also see a situation where if you're tweaking capital requirements and raising capital requirements, then maybe the SLR becomes less of a particular issue for these banks in terms of how they think about structuring their balance sheets.

Guida: But I guess inherent in the question is, "Well, what are the regulators going to do?" And my sense of it is that I don't think that anything is going to happen anytime soon. I think that there is very little consensus on how to handle this issue. Because there's always these overarching concerns that if you exclude cash and treasuries, then maybe it's a slippery slope because the leverage ratio is supposed to be like, "No, we're being agnostic towards what the asset is,” and so once you start excluding things... There was a proposal in 2018 that was never finalized, that would've tied the level of the supplementary leverage ratio to a risk-based measure. I think that, that probably won't have enough support to actually go through. There may even be differences of opinion on the board on how to handle this. And one point that I do think is very relevant is, Michael Barr, when he was testifying recently, was asked about this particular issue.

My sense of it is that I don't think that anything is going to happen anytime soon. I think that there is very little consensus on how to handle this issue. Because there's always these overarching concerns that if you exclude cash and treasuries, then maybe it's a slippery slope.

Guida: And he said, he didn't word it quite like this, but he basically said the SLR does have some impact on the Treasury market, but I think it's very low on the list. And I thought that that was kind of interesting that it indicated that maybe he's not totally inclined to make changes to the SLR specifically, to deal with the Treasury issue. And like I said, there's a lot of different ways that you could structure the Treasury market that would make that type of exclusion less necessary. But also, I mean, this isn't like a partisan issue. There are lots of people who are on both sides that would potentially support exclusions because it is ultimately a market functioning issue. I think there are a lot of people who think that this is just the banks looking for ways to lower their capital requirements, and banks do always look for ways to lower their capital requirements, but it does seem to legitimately affect their decision-making. Now, how much is a little bit harder to parse out.

Beckworth: Well, let me make the case for why the SLR tweak would be useful at this time. When it was first introduced 2014, 2015, the Fed's balance sheet was much smaller. There weren't as many reserves and the expectation is that it would stay smaller, even get smaller. And now we have a huge Fed balance sheet over $8 trillion. It may shrink some, but no one expected the Fed's balance sheet to be that big, which in turn means the banks have to hold a lot of reserves. But they never intended the SLR to be the binding constraint, right? It's supposed to be a backup, as you mentioned, to the risk weighted measures for capital. And the fact that it's becoming the binding constraint kind of defeats the whole purpose of it.

Beckworth: With that said, I understand the concern that it could be a slippery slope. So I believe the Bank of England tweaked their SLR and they only took out reserves, they kept treasuries, I may be wrong on that. And then they adjusted the other requirements so that the overall level capital remained the same. So there are ways to do that, tweak, or the adjustment where you wouldn't necessarily lower overall capital. Let me ask this question though. Who actually makes that decision? So is it the Fed, is it the Treasury? If they were to relax that or to adjust it, who is the deciding authority?

Guida: Yeah, so it's not Treasury, it's the Fed... Well, so there's the Fed, the Office of the Comptroller of the Currency and the FDIC that control capital requirements. They all sort of have different pieces of the capital puzzle. So the Fed is the holding company level. The FDIC is the insured depository institution level, and the OCC is the national bank. But they would move in concert, presumably, would be the way to do it. But you wouldn't actually... I mean you could, now that I say that, you could have different rules for different levels. And I think this is… I mentioned that 2018 proposal, the FDIC did not join that proposal and I think it was partially because the way that it would affect capital at the insured depository institution was sort of unworkable from the FDIC'S perspective. But you could treat it differently depending on what level of the bank you're talking about. But they would be the ones who make that decision. And then for the Fed, it's the board specifically, because there's the Federal Open Market Committee, which also includes the reserve bank presidents. They vote on monetary policy issues, but the reserve bank presidents don't have a vote on regulatory policy.

Beckworth: Okay, final question. What about the other options such as central clearing, all-to-all, markets in Treasury? Are there any prospects for those becoming a reality? I know the SEC has proposed a change or have they actually in implemented this change for the market?

Guida: So the SEC definitely put out a proposal on central clearing. I'm actually blanking on whether they've finalized it or not. But yeah, they've moved to basically increase central clearing, which would help reduce some of the burden of... The netting would happen at the clearing house as opposed to everyone else would be taking on less risk, which is the point of having a clearing house. And so there is some central clearing already in the Treasury market, but it would try and expand that as an effort to make things more stable in the Treasury market. And then all-to-all trading, more the stock market, where anybody can trade with anybody, and that's kind of what I was talking about earlier when I was saying there are potential ways you could change the structure to make banks less central. I actually think that that is more of a prospect than it maybe used to be.

Beckworth: Okay.

Guida: I don't know that we're actually headed in that direction, but I think that it's something that's seriously being considered. And you had some of the regulators in Treasury put out a report basically saying that this is something that they should look at, which is pretty notable. I will say, I do think it's kind of funny because in the stock market, one of the issues that people have been talking about is that you have all these big wholesalers like Citadel and Virtue who are facilitating so many trades within them. So it's kind of funny to me that it's like the stock market is becoming more like having these central players while we’re talking about having the Treasury market become a little bit more decentralized and maybe they're sort of moving towards each other in the way that they're structured.

All-to-all trading, more the stock market, where anybody can trade with anybody, and that's kind of what I was talking about earlier when I was saying there are potential ways you could change the structure to make banks less central. I actually think that that is more of a prospect than it maybe used to be...I don't know that we're actually headed in that direction, but I think that it's something that's seriously being considered.

Beckworth: So [what are] the prospects in 2023 of any those coming to fruition?

Guida: So central clearing, it seems like that's definitely something that they're actively trying to make happen. In terms of all-to-all trading, I don't know. I mean, these issues often take years to sort out as you know as well as I do. The government needs to be able to talk about all of these different things. The Treasury market is also weird because it's like the SEC is in charge of part of it, the Treasury is part of it, the Fed has an important rule. And so you kind of have to get everybody on the same page on what they want to do.

Beckworth: Okay. With that, our time is up. Our guest today has been Victoria Guida. Victoria, thank you so much for coming back on the show.

Guida: Thanks for having me back.

Photo by Win McNamee via Getty Images

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.