Fed looks at way to shift big-bank losses to investors

31 Oct 2015 | Author: | No comments yet »

Janet Yellen just got some pretty bad news.

Hillary Rodham Clinton said this week that, if it came to it, she would let a big bank fail — and it would not be surprising if other presidential candidates adopted her anti-bailout stance.Two days after the Federal Reserve released what was allegedly its most hawkish statement in months came a reminder that the path toward a rate hike won’t be an easy one.The Federal Open Market Committee, the Federal Reserve’s rate-setting body, opted not to raise interest rates at its meeting last week but suggested that it could still approve an increase when policy makers meet again in December. One of the main economic factors for Fed officials when it comes to assessing the right time to start hiking rates is wage growth, tied with the consumer spending that is supposed to follow.

Over the summer, most economists expected the Fed to raise its benchmark interest rate, which has been near zero since 2008, at its September meeting. The new regulation seeks to inflict the costs of a failure on investors who have lent to an ailing bank and on its shareholders, rather than on taxpayers.

The big releases of the day were on personal income, which increased just 0.1 percent in September, missing even the meager consensus estimate of 0.2 percent, and the University of Michigan consumer confidence survey, which, at 90, whiffed as well with its second-lowest reading of the year. The hope is that the rule would work without greatly disrupting the wider market and economy. “The proposal is another important step in addressing the ‘too big to fail’ problem,” said Janet L. Below the Wall Street radar, though, came another report that doesn’t garner the headlines but is believed to be one watched closely by Fed Chair Janet Yellen and her fellow monetary policymakers: The employment cost index. Yellen, the Fed chairwoman, referring to the notion that the government has to bail out big banks because letting them fail would cause severe collateral damage in the economy.

The quarterly release from the Bureau of Labor Statistics showed that compensation costs for nongovernment workers rose just 0.6 percent in the three-month period — about what economists had expected but not much to move the inflation needle. On an annualized basis, compensation costs rose just 2 percent, which actually is a decline from the 2.2 percent increase realized for the same period a year ago. And if large banks have to consistently pay more for their financing, they may decide to shrink to make their businesses more profitable. “The proposal should also improve market discipline,” Daniel K.

In the statement following last week’s meeting, the Fed said it could raise rates in December if it sees “some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” “Real estate agents will say the best time to buy is always now,” joked Aaron Jackson, an economics professor at Bentley University in Waltham. The banking industry, perhaps wanting to avoid harsher measures, has mostly embraced the system of winding down large banks that was set up under the Dodd-Frank Act, which Congress passed in 2010 to overhaul the United States’ shaky financial system. Still, the Fed’s new rule, which focuses on the country’s eight largest banks, like Citigroup and JPMorgan Chase, could increase costs for an industry that has already borne the burden of hundreds of new regulations. With the slow wage growth, core inflation as measured through Yellen’s preferred indicator, the personal consumption expenditures index, is tracking at just 1.25 percent, according to Steve Blitz, chief economist at ITG. “The FOMC, if true they are tied to trends, can only be disappointed by the trend in consumption and wage growth coming out of the third quarter,” Blitz said in a note. “Because [if] they really, really, really want to move 25 basis points in December they have to be, by their own rules, now focused on whether the individual data points for the economy in the next six weeks indicate a change in trends to the upside.

In other words, the next two payroll numbers mean everything.” Economists currently expect next Friday’s nonfarm payrolls report to show a gain of 180,000 for October, which despite being below trend would indicate an improvement from September’s 142,000 gain. Mortgage rates have fallen over the past several weeks, slipping to 3.76 percent last week for a 30-year loan, according to Freddie Mac, the government-owned mortgage company. A quarter-point increase on a 30-year fixed-rate mortgage for $250,000 means another $40 in payments every month, said Danielle Hale, a managing director at the National Association of Realtors.

Greg McBride, an analyst at Bankrate.com, a consumer financial website, said the stock market might swing up and down on the day the central bank makes its decision, but when the dust settles, consumer credit rates, such as mortgages, are unlikely to change very much. “That idea of just rushing to buy a house now before mortgage rates go up, the danger there is you leap before you’re really ready,” McBride said. “It’s like getting married because there’s a sale at the bridal shop.” Home equity lines of credit are popular for financing home renovations. A bank’s borrowings are not usually seen as a stable form of capital because the money has to be repaid, and thus may not be around to absorb losses if the bank’s creditors flee. A slight increase in the Fed’s rate is unlikely to raise yields much, McBride said, so it would be unwise to purchase a longer-term CD because it could lock savers into a long period of lower-than-inflation returns.

Chris Chen, a Waltham financial planner, said low interest rates have led many investors to abandon savings instruments and income-generating bonds in favor of riskier investments like stocks. By making it clear upfront who will bear a failing bank’s losses, the Fed hopes to dispel much of the chaos and panic that can occur when a large financial firm is foundering. The eight banks — which also include Goldman Sachs, Morgan Stanley, State Street, Bank of New York Mellon, Bank of America and Wells Fargo — have time to raise new debt. Analysts added that it was hard to identify which banks already complied because it was not clear how much of a bank’s current long-term debt would qualify for inclusion in the buffer. Also on Friday, the Fed joined other federal regulators in approving a rule that aims to strengthen the market for swaps, a type of financial contract that is traded heavily on Wall Street.

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