Some of the nation’s largest banks are balking at the capital requirements imposed on them by Congress after the 2008 financial crisis. The Washington Post recently quoted Lloyd Blankfein, chief executive of Goldman Sachs, telling investors earlier this year, “Left to our own devices, we wouldn’t hold as much capital as we’re holding.” J.P. Morgan Chase’s Jamie Dimon has made similar observations.
With last week’s House vote to repeal and clarify provisions of the Dodd-Frank Act, there might soon come a day when the big banks will again be, indeed, “left to their own devices.” Caveat taxpayer. Of course, the debate will continue for years about the right balance between ensuring these financial institutions have a level of capital to remain sound and solvent during market downturns – even sharp downturns – and making sure they can fuel economic activity by deploying capital in the marketplace.
That said, it would be reckless to forget that overleveraging and undercapitalization cost American taxpayers hundreds of billions of dollars in 2008-9 as banks neared collapse and the government sponsored enterprises (GSEs), Fannie Mae and Freddie Mac, landed in a “temporary” conservatorship that continues to this day. On top of that, the Net Worth Sweep denies the GSEs their ability to maintain adequate capital bases. Given the increasing exposure to a shortfall, this represents flagrant gambling with taxpayer money by policymakers. The sooner the Federal Housing Finance Agency and the Treasury Department end this practice, the better.
Meanwhile, if the big banks are itching to be free of what they regard as onerous capital burdens, it is all the more reason why they should not be permitted to supplant Fannie Mae and Freddie Mac in the secondary mortgage market. By design, big banks and the GSEs have two different, albeit complementary, missions and functions. The blurring of these roles was a contributing factor heading into the 2008 meltdown. Now that the GSEs have unloaded large portions of their investment portfolios, paid the taxpayers back $80 billion in excess of what was leant to them, and operate with more stringent lending requirements, they are better positioned to serve their historic mission. The key element that is missing is capital. Once the illegal Sweep and the conservatorship end, the GSEs can apply revenues to capital reserves. This will protect taxpayers and restore the rights of shareholders.
Until then, it is critical to remember that together the GSEs are the anchors of the secondary mortgage market that fuels homeownership. Together they back some $5 trillion in mortgage debt. Well capitalized GSEs enable a variety of lenders, including big banks, to make new home loans. Liquidity in mortgage markets is good for prospective homebuyers. And it is good for banks. To try to dismantle and redesign them is both unnecessary and risky, especially if banks are seeking freer rein.
If the big banks think they can keep the American economy humming with less reserve capital, then they should continue to press their case on Capitol Hill and to the Trump Administration. But it would be irresponsible to apply this thinking to Fannie and Freddie, especially if banks prevail. Banks depend on the GSEs operating with adequate capital. Sound and solvent GSEs will ensure banks have the confidence and the incentive to keep making loans, even outside high-end markets, thereby spurring activity in the housing sector, which represents at least one sixth of the U.S economy. When the GSEs are required to keep their reserve capital at a high enough level to operate with soundness and solvency even under adverse economic conditions, consumers will benefit by being able to access financing through banks. Banks will make more money. And taxpayers will be unburdened by the prospect of additional bailouts – at least additional GSE bailouts.