Federal Reserve Plays Jenga with US Banking System

If you’ve ever played Jenga, you know each player takes turns pulling blocks out of the core of a tower and then placing them on top. The tower gets less and less stable as the game goes on, until eventually it comes crashing down.

This is kind of like what the Federal Reserve does with the US banking and monetary system – except they actually claim they are making things more stable as they go.

Comments by two Federal Reserve governors last week indicate the central bank will likely require American banks considered “too big to fail” to further bulk up their balance sheets in order to protect against big losses and potential future bailouts in an economic crisis.

This is yet another demonstration of the arrogance of central bankers. They think they can control and stabilize an inherently unstable monetary and banking system. In fact, their constant intervention arguably creates a great deal of the economic instability they claim to protect us from.

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According to the Wall Street Journal, the new capital requirements will likely be formally proposed later this year and will go into effect in 2018. Even so, banks will have to start adjusting their finances sooner in order to phase in the requirements:

Fed governors Daniel Tarullo and Jerome Powell, in separate public comments, said the central bank would probably decide to require eight of the largest US banks to maintain more equity to pass the central bank’s annual ‘stress tests,’ exams designed after the financial crisis to measure the ability of banks to weather a severe downturn…The proposal is the latest salvo in a battle between banks and regulators since the financial crisis over how much the largest banks need to reorient their business models to protect against the possibilities of big losses and another taxpayer bailout. Wall Street argues the banks have done enough already to guard against another crisis and that any further tightening risks undermining the vitality of the financial system.”

JP Morgan Chase ranks as the largest US bank by assets. CEO James Dimon said of the proposal, “This is not good for us.”

The WSJ explained exactly how the requirement would impact the big banks:

JP Morgan says current rules require the bank during normal times to maintain an additional capital buffer of 3.5% of certain assets, compared with banks not considered systemic. That requirement previously was 4.5% before the firm made some moves to shrink over the past year…Citigroup Inc., Bank of America Corp., and others face similar, though less strict, capital ‘surcharges,’ which are tailored to a bank’s size, complexity and links to other firms, aiming to capture their impact on the financial system. The other banks covered are Goldman Sachs, Morgan Stanley, Wells Fargo & Co., State Street Corp., and Bank of New York Mellon Corp…The specific change that Messrs. Tarullo and Powell previewed Thursday involves taking the higher capital requirements big banks now face during normal times—the ‘surcharge’ for being big—and forcing them to meet those standards during periods of stress as well. That effectively forces those institutions to hold even more capital on their books throughout the business cycle, as capital levels would likely fall during a recession when losses would rise. Fed officials have long said they were considering such a requirement, but these were the most explicit comments confirming that they are likely to impose that rule.”

Shrinking the largest banks is one of the underlying aims of the capital requirements. Some advocate forcibly breaking up the big banks, but he Fed prefers this more subtle approach as Powell explained during a recent banking conference:

I have not reached any conclusion that a particular bank needs to be broken up or anything like that…the point is to raise capital requirements to the point at which it becomes a question that banks have to ask themselves.”

Goldman Sachs Group Inc. Chief Economist Steven Strongin called it “a tax on banking.” He said the new rules go beyond what was necessary to prevent the 2008 financial crisis and have become harmful:

This hurts those individuals that are dependent on banking services, such as midsize companies, small businesses and low-income consumers.”

These regulations are supposed to make the banking system more stable. But they actually create even more uncertainty in an inherently unstable system pushed along by the whims of a few central bankers who think they are smart enough to micromanage the entire thing. The WSJ described just how much uncertainty these rules create:

“…banks are constantly trying to adjust to a shifting regulatory environment. The stress tests are something of a black box—intentionally designed by the Fed as such to keep banks from trying to game them. So that keeps banks off balance, even as they spend millions and hire thousands on compliance efforts meant to satisfy regulators and pass the tests.”

This is not to side completely with big bank executives. They create their fair share of problems. Not to mention that the entire fractional reserve banking and monetary system is fundamentally unstable at its core. But the central bankers don’t make things better with the arbitrary requirements they brew up out of thin air. All they are doing is pulling more blocks out of their Jenga tower.

We all know how that will end.

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