President Donald Trump shakes hands with Kevin Warsh before a swearing-in ceremony to become the new chair of the Federal Reserve at the White House in Washington last Friday.Anna Moneymaker/Getty Images
The Kevin Warsh era has begun at the U.S. Federal Reserve – and change is in the air.
Mr. Warsh, 56, was sworn in as the Fed’s new chairman at the White House last week. His accession capped a transition period marked by criticism that the world’s most important central bank could become susceptible to political interference under his leadership.
President Donald Trump, who waged attacks on former Fed chair Jerome Powell, made a clumsy attempt at damage control during the swearing-in ceremony on May 22.
“I want Kevin to be totally independent,” Mr. Trump said.
But he muddied the waters by chirping: “Thankfully, unlike some of his predecessors, Kevin understands that when the economy is booming, that’s a good thing.”
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Economists and investors have largely focused on what that mixed messaging portends for the future direction of interest rates. The Fed, however, also plays a key role as a financial regulator, and there are signs that Mr. Warsh will hasten the Trump administration’s agenda to loosen rules for banks.
Indeed, there is a broader push for financial deregulation happening south of the border – one that could be a boon to banks, including Canadian lenders with U.S. operations, if it doesn’t result in excessive risk for the financial system.
Leading up to his nomination, Mr. Warsh was dropping hints about his vision for “regime change,” stressing the Fed had strayed too far from its core mandate on monetary policy.
For instance, Mr. Warsh told Barron’s last fall that if given his druthers, he would limit the Fed’s involvement in banking supervision because he believes it is more appropriate for political agencies to oversee such regulation.
Now that he has clinched the job, Mr. Warsh appears to have a key ally in Michelle Bowman, who is vice-chair for supervision of the Federal Reserve Board.
Ms. Bowman has spent months telegraphing plans to boost mortgage lending by banks, potentially by tweaking the amount of capital lenders are required to hold to backstop home loans.
Those capital requirements were strengthened after the U.S. subprime mortgage crisis morphed into the great financial crisis of 2008 and 2009.
The result was that financial institutions pared back their lending to riskier homeowners, but so-called shadow banks subject to little or no oversight quickly filled the void.
In a speech this past February, Ms. Bowman blamed an “over calibration” of capital rules for dramatically shrinking banks’ share of the U.S. mortgage market.
She noted that banks originated roughly 60 per cent of mortgages in 2008, but that figure was 35 per cent in 2023.
“This misalignment between capital requirements and actual risk has important consequences,” said Ms. Bowman, adding that “disproportionately high capital” requirements reduce banks’ ability to lend.
Since the great financial crisis, large banks have more than doubled their capital levels, an increase that amounts to more than US$1-trillion, according to Fed data.
In a memo dated March 19, the Fed outlined proposals to revise the capital rules for lenders, including one that recommends revising the surcharge for global systemically important banks.
“The proposals would modernize the Board’s capital requirements by improving their risk sensitivity and reducing burden, while retaining their robustness,” stated the memo.
Last year, the Fed proposed changes to its annual stress test and modified other regulatory capital standards.
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Consultancy Alvarez & Marsal estimates in a new report that the U.S. government’s broader deregulation drive could unlock roughly US$2.6-trillion in lending capacity for U.S. banks – funds the banks are already using in their operations.
“U.S. banks have begun deploying the additional capital headroom, as evidenced by increased organic asset growth, M&A activity, and capital distributions,” states the report. “Stock valuations have risen in parallel.”
This is also raising expectations of additional capital returns to shareholders, either through dividends or share buybacks.
Back in 2010, when Mr. Warsh was a member of the Federal Reserve Board, he offered his opinion on the central bank’s role as a financial regulator.
“Policymakers, in my view, should be more focused on what constitutes effective prudential supervision, rather than be diverted to the less consequential discussion as to who should perform it," he said in a speech titled “Regulation and Its Discontents.”
These days, the prospect of streamlined lending rules and capital requirements amounts to good news for banks and their shareholders.
Still, given the 2023 regional banking crisis, it is not at all clear that regulators have a better handle on interest-rate risk. That’s a concern because deregulation is a form of stimulus.
It seems Mr. Warsh’s challenge, as Mr. Trump put it, is to let the U.S. economy “boom” without letting it “go crazy.”
Whatever that means.