Jerome H Powell: International financial regulatory reform
Speech by Mr Jerome H Powell, Member of the Board of Governors of the Federal Reserve
System, at The University Club, New York, 2 July 2013.
* * *
Thank you so much for inviting me to speak today.1 I join others in thanking Mr. Stephan for
his service, and in welcoming Ms. Stirbock to her new role as Chief Representative of the
Deutsche Bundesbank in the United States. I look forward to working with both of you, and
with your colleagues, in the coming years. The Federal Reserve places great importance on
our relations with the Bundesbank. Few such relationships have been as important, over the
decades, in promoting financial stability and prosperity around the world.
Governments, central bankers, and financial regulators labor today in the long shadow cast
by the global financial crisis, and that likely will remain the case for many years. Against that
background, I will touch briefly on fiscal and monetary policy here in the United States,
before turning to financial regulatory issues.
It has long been clear that, starting in this decade, the United States would begin to face
longer-term fiscal challenges due to the aging of our population and our high and fast-rising
per capita health-care costs. Over the next 20 years, it is projected that the ratio of our retired
elderly to our working-age population will increase sharply from about 23 percent to about
36 percent. And, as you surely know, our per capita health care costs are far higher than
those of other advanced economies, and have risen over time at a faster pace than per
capita income. The combination of these two factors will put the U.S. federal budget on an
unsustainable path if appropriate measures are not taken.
At the end of 2007, just prior to the onset of the last recession, the United States had federal
government debt equal to about 36 percent of the size of our annual gross domestic product
(GDP) - a moderate level. Since 2007, and largely as a consequence of the recession and
policy actions to help alleviate its effects, the U.S. federal government's debt-to-GDP ratio
has increased to around 75 percent. It is projected to remain near this level for the remainder
of the decade under current federal budget policies. This high level of federal government
debt leaves U.S. policymakers with less "fiscal space" than may be required to deal with
expected increases in retirement and health-care costs, or with unanticipated economic
shocks.
Over the last few years, the fiscal authorities have cut federal spending and raised taxes, and
our Congressional Budget Office estimates that these fiscal headwinds will reduce real GDP
growth by about 1.5 percentage points this year from what it otherwise would have been.
Nevertheless, as a nation, we have not yet addressed in a fundamental way our longer-term
budget challenges, particularly those associated with federal health-care programs. So I
have no doubt that fiscal policy issues will retain an important and highly contentious place
on the political agenda for many years here in the United States, as in Europe.
I will turn for a moment to monetary policy. The Congress has tasked the Federal Reserve
with conducting monetary policy to foster stable prices and full employment. Today, inflation
is well below our 2 percent longer-term objective, as measured by prices for personal
consumption expenditures. And although the unemployment rate has declined notably since
its peak in 2010, it remains well above our estimate of a longer-run, more normal level. I
expect that inflation will return gradually to our 2 percent objective, and that we will continue
to make progress in reducing unemployment. In the meantime, the case for continued
support for our economy from monetary policy remains strong.
With these fiscal headwinds and the lingering effects of the recession, growth has remained
in the range of 2 percent since 2009. But today, our private sector shows real signs of
underlying improvement. Auto sales are strong, as is activity in our energy sector. Our
housing market, which was at the heart of the crisis, is now recovering strongly. House prices
are rising, and that is supporting improvement in household net worth and consumer
attitudes. Homebuilders are responding to this price signal with rising housing starts, which
will support job growth. Together, these and other factors give grounds to hope for the kind of
self-reinforcing cycle of economic growth that we have been waiting to see.
And as our economy has gradually improved, it has become possible, and appropriate, for
the Federal Reserve to provide clearer guidance on the path of monetary policy. In all
likelihood, this path will involve continued support from accommodative monetary policy for
quite some time.
Meanwhile, financial regulators around the world are engaged in a historic and sweeping
renovation of the global financial architecture. The scope of this global regulatory project is
enormous, and I will touch on only a few of its elements. One of the most important goals is
to ensure that banks have adequate capital to withstand severe financial stress. I am pleased
that, just this morning, the Federal Reserve Board finalized the Basel III capital requirements
for bank holding companies and Federal Reserve state-chartered member banks. The other
U.S. bank regulatory agencies are on track to adopt the same set of rules for the institutions
they regulate over the next week or so. The Basel III capital reforms will substantially
improve the resiliency of global banks and will serve as the cornerstone of the global
regulatory effort to safeguard the stability of the world's financial system.
Both in the United States and in Europe, some parts of the reform agenda will take longer to
complete. For example, I note the ongoing progress toward achieving one of the most
ambitious and important regulatory goals: the creation of a European banking union. It is
clear that this challenging project will be the work of many years; indeed, it is not for an
American to educate Europeans on the challenges of international cooperation. But the
importance of this project for Europe's future is equally clear. The recent agreement on
harmonizing national resolution regimes is an important achievement, and a milestone on the
road to longer-term goals such as a single, centralized resolution authority.
Another reform that will take time to complete is the establishment of a global framework for
resolving large, systemically important banks. Work to enable resolution of such institutions
with diverse cross-border operations is especially important, and especially daunting. The
challenge is not so much to allow such institutions to fail, but rather to contain their failure so
that it does not inflict enormous collateral damage on innocent bystanders and the broader
economy. As many of you know, in the United States, the Federal Deposit Insurance
Corporation is developing a preferred approach to resolution for such rare cases: the
singlepoint-of-entry (SPOE) approach. This approach may be gaining some traction internationally.
In my view, SPOE can be a classic "simplifier", making theoretically possible something that
seemed impossibly complex.
Under the SPOE approach, the home country resolution authority for a failing banking firm
would effect a creditor-funded parent company recapitalization of the failed firm. To do so,
the resolution authority would first use available parent company assets to recapitalize the
firm's critical operating subsidiaries, and then would convert liabilities of the parent company
into equity of a surviving entity. This approach would have the effect of concentrating the
firm-wide losses on the parent company's private sector equity holders and creditors. The
SPOE approach places a high priority on what your own President Weidmann recently
described as "the principle of liability", meaning that those who benefit should also bear the
costs.
Perhaps the greatest challenge for the resolution of a systemic global bank is the possibility
that public or private actors in different countries might take local actions that would cause
the overall resolution to spin out of control. Creditors and counterparties of solvent operating
subsidiaries might rush for the exit if they are unsure of their status. As a subsidiary comes
under increasing stress, authorities might preemptively ring-fence local assets. The process
of resolution will need to be fully worked out and understood beforehand by market
participants, regulatory authorities, and the general public. It will be absolutely essential to
build trust among all parties, and especially between regulatory authorities.
Much remains to be done in eliminating "too-big-to-fail". The Federal Reserve is considering
a requirement that systemic institutions maintain sufficient long-term debt at the parent
company level to absorb losses and recapitalize operating subsidiaries in the event of failure.
We expect to propose such a requirement later this year. I share the view expressed recently
by several of my Board colleagues that the work of large bank resolution is not complete, and
that further measures may be necessary. No one should doubt that the Federal Reserve is
committed to completing this project.
Reaching agreement on a cross-border resolution process will be challenging. Our financial
services industries and our economies differ in many ways. But we have a shared interest in
financial stability, in reducing moral hazard, and in protecting taxpayers.
On that note, I will briefly discuss the Fed's proposal for oversight of foreign banks operating
in the United States, which carries out a mandate from the Congress under the Dodd-Frank
Wall Street Reform and Consumer Protection Act.22 Our proposal represents a targeted set
of adjustments aimed at reducing the risks posed by the U.S. operations of large foreign
banks to U.S. financial stability that were revealed during, and in the aftermath of, the recent
financial crisis. The proposal is not intended to create a disadvantage for foreign banks in the
U.S. market. Rather, the proposal is part of a larger set of regulatory reforms that
substantially raises standards for all banking organizations operating in the United States
and aims to achieve the goals we share with Germany: vigorous and fair competition and a
stable financial system. Indeed, in some sense it follows the lead of the European Union and
its member states in ensuring that all large subsidiaries of globally active banks meet Basel
capital rules. We believe that our foreign bank proposal, which would increase the strength
and resiliency of the U.S. operations of these firms, would meaningfully reduce the likelihood
of disruptive ring-fencing at the moment of crisis that could undermine an SPOE resolution of
a large foreign bank. We are fully committed to the international efforts to address
crossborder resolution issues and to maintaining strong cooperation between home and host
supervisors during normal and crisis periods.
I will close by observing that the international effort to strengthen financial regulation cannot
succeed unless each nation understands the goals and challenges faced by its partners. The
Federal Reserve and the Bundesbank have a long history. I believe there is a trust between
us that is the basis for collaboration. I look forward to working with you to make the financial
system safer and stronger.
Thank you.