Bowman and "Pragmatic" Policy

Fed Governor Michelle Bowman gave a very interesting speech last week. You might miss some of the news in her un-grumpy even tempered tone. Not much would be that newsworthy coming from a critic, but it is refreshing from a Fed insider.

The first question I like to ask when confronted with a policy issue is, "Why are we here?"

Later

When we consider drafting a new regulation, we should always ask "What problem would this new regulation solve?" … Ideally, the process would begin by identifying the problem, then move to an analysis of whether proposed solutions are within the agency's statutory authorities, and finally whether targeted changes to the regulatory framework could result in improvements, remediation of gaps, or elimination of redundant and unnecessary requirements.

So much policy-making is answers in search of a question. Kudos to Bowman: Let’s start by defining the question!

The sheer scope of the Fed's powers can present a temptation to go beyond the statutory authority. For example, to play a more active role in the allocation of credit, or to displace other sources of bank funding even when market sources of liquidity are functioning well. It could also include the temptation to venture into policy matters unrelated to the Fed's responsibilities that are better addressed by Congress or other policymakers (here, a push for banking sector climate change related regulation comes to mind).

My emphasis. Great power and independence can only come with a limited mandate, that says what the agency will not do as much as what it will do. It is lovely to see a Fed board member so well articulate the need to avoid endless expansion of the institution’s activities.

A banking system that is safe and sound yet irrelevant would not fulfill our regulatory objectives, but would be the inevitable outcome of following a path that strives for elimination of risks rather than promotion of effective risk management.

The Nuclear Regulatory Commission made nuclear power safe by essentially banning new construction. Let’s not go there. Actually, the Fed threatens to make banks safe by funneling most of their activity off to unregulated fintech companies. The overall safety of that system is obvious. Later,

Our responsibility is not to look only at whether a proposal will promote greater safety and soundness, but to consider the broader context, including whether regulatory incentives will skew the allocation of credit, adversely affect capital markets, or push traditional banking activities outside of the banking system into less regulated non-banks.

The lesson of SVB:

Take for example the failure of Silicon Valley Bank (SVB), and the regulatory response. … The interest rate and funding risks, rapid growth, and the idiosyncratic business model and concentrated customer base of the bank, were apparent and obvious. These risks were mismanaged by SVB and not acted on early enough by bank supervisors.

… yet in the aftermath of SVB's demise, we have focused on regulatory proposals ranging from substantial increases in bank capital requirements, to pushing down global systemically important bank (G-SIB) and large bank requirements to much smaller firms, finding supervisory deficiencies in the management of well-capitalized and financially sound firms, and considering widespread changes to the funding and liquidity requirements and expectations that apply to all banks.

I read the regulatory trend as simply a steamroller moving on its own momentum and ignoring the dumpster fire out the window, rather than a misconceived response to SVB. But either ignoring SVB or going after unrelated issues in response is a great example of answers in search of questions.

I also am sad that the praiseworthy attempt to raise capital got lost in thousands of pages of Basel Blather.

…when agencies overwhelm the process by publishing thousands of pages of rulemakings in a short period of time, the public's ability to provide meaningful feedback on our rules is compromised. Last year the federal financial agencies published over 5,000 pages of rules and proposals

Another hint of mission creep

A deliberate, transparent, and fact-based approach to pursuing statutory objectives also serves the goal of avoiding the impression of pursuing unrelated policy goals, particularly those that venture into political concerns outside of an agency's purposes or functions. Promoting safety, soundness, and financial stability should not devolve into an exercise of regulatory allocation of credit—picking winners and losers—or promoting an ideological position through more open-ended processes like bank supervision and examination.

I wish she had been a little more concrete here. One concrete example:

When agencies prioritize the creation of new regulation in the absence of a statutory mandate, harmful and unintended consequences can result. One such example is the adverse effects of regulatory constraints on Treasury market functioning. Rules like the Supplementary Leverage Ratio, the G-SIB Surcharge, and the Liquidity Coverage Ratio pose known and identified constraints on the Treasury market that may contribute to future stress and market disruption if left unaddressed.

In “known and identified” she recognizes that even the Fed knew for a long time there was a problem in need of fixing. But since the problem is an unintended consequence of the Fed’s regulatory expansion, inertia seems to be strong.

On monetary policy, in various places,

we have not yet met our inflation goal and, as I noted earlier, progress in lowering inflation appears to have stalled…I see greater risks to the price stability side of our mandate,

Soft landing, or stall 50 feet off the runway? Inflation is like cockroaches. You had a thousand, you get it down to three. That’s not the time to ease up.

It is important to note that monetary policy is not on a preset course….I am pleased that the November post meeting statement included a flexible, data-dependent approach, providing the Committee with optionality in deciding future policy adjustments.

As we look forward to the Fed’s new “framework,” I take that as an indication that "forward guidance” will fade. The Fed made unconditional projections, almost promises, of where interest rates would be in the future, and almost explicit promises that interest rates would react slowly to future inflation. Then the Fed reacted slowly to inflation. The “data dependent” (dare I say rule?) strategy, in which the Fed lets us know instead how it will react to events, may be on the rise.

Fed critics and at least one Fed insider seem to be converging a bit!