K Street Meets Main Street
A CREFC Government Relations Blog.

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  • * written by the CREFC Government Affairs team *

    In our last installment, we drilled down into the reason why the broader Congressional agenda had been held hostage to the various health care machinations. With healthcare “repealorama” behind us, all but settled by a final vote not to repeal in the Senate on July 28th, what is left to do and how will Congress go about it?

    As a reminder, and as you have likely heard on most any news channel, republicans (who control Congress and the Presidency) are hungry to post a win before the year is up and they enter into 2018, yet another election year. One of their major platform issues has been tax reform, and it is squarely in the bulls eye of President Trump, Senate Majority Leader McConnell (R-KY) and House Speaker Ryan (R-WI). That said, Congress has been on its typical “summer recess” for the majority of August in order to go back home and meet with constituents. Congress is set to return in September 5th after the Labor Day weekend. However, before they can get to tax reform, Congress has a few crucial items it must pass, and it has given itself all of 12 legislative days to do so.

    Starting September 5th, Congress must pass two vitally important measures by September 30th: First, they must pass a bill to raise the debt ceiling in order to avoid a default on U.S. debt. Second, funding for fiscal year (FY) 2017 budget for the government (think funding for Departments, such as Treasury, Health and Human Services, etc.) also runs out on September 30th. Without some form of legislation to pass a FY 2018 bill or a continuing resolution (CR), which continues the current rate of funding for said programs, Departments will be forced to close their doors until authorized by Congress to spend money again.

    On top of this, there are other tax items (see below), as well as items important to our industry, such as flood insurance and the EB-5 program, that will also expire on September 30th.

    But before we get into the sausage making of how this may (or may not) work itself out, let’s look at the bright side on this: The more time Congress spends back home listening to frustrated (sometimes downright hostile) constituents, the better the odds for positive outcomes. Eventually those elected officials will fear being held accountable for the complete lack of legislative achievement – quite the contrary of what many ran on in 2016 (health care and tax reform). While we wait for the chambers to reconvene September 5, let’s look at what they will return to and what they have to do to keep the .gov lights glowing.

    The September Lineup as We Now See It

    Continuing Resolution; a.k.a. Keeping the .gov Lights on

    A government funding bill is needed before October 1 in order to keep the .gov lights on. The main hurdle is garnering the necessary votes from dozens of Senate Democrats and possibly a majority of House Democrats. Earlier this year in May, 103 House Republicans (out of 238) voted against the Omnibus appropriations bill, which is what funded the government through September 30. In the wake of a deal, there was anger from the White House on the “bad” April deal. The president’s ire was further fueled by Democratic cheering that the deal failed to include the president’s priorities as outlined in his ‘America First’ budget blueprint (building the Wall, defunding sanctuary cities and Obamacare) and bolstered some of theirs (increased funding for the National Institutes of Health). Shortly after the April vote, Trump tweeted out a series of tweets, concluding with “Our country needs a good ‘shutdown’ in September to fix mess!”

    On Tuesday, in Arizona, Trump doubled-down on this argument at a campaign rally, stating “If we have to close down the government, we are building that wall.”

    We would expect a much tougher White House negotiating perspective this time around on some of the hot-button items for both sides that will be included in the government funding debate, including:

    • The Wall
    • Planned Parenthood
    • ObamaCare subsidies
    • Sanctuary cities
    • IRS & EPA funding
    • Defense spending

    Other Programs that Will Expire September 30th without Government Reauthorization

    National Flood Insurance Program

    The House and the Senate have both committed to the reauthorization of the flood insurance program. The question revolves around how it gets done. Our best guess at this point is that committee work continues on the program reauthorization and bipartisan reforms, but ultimately the lever that extends the program will come in along with the next Continuing Resolution. Perhaps temporary, we expect the program to continue unabated – especially as we enter hurricane season.

    EB-5 Immigration Program

    EB-5, despite the advocacy around it, seems to be more of an afterthought this season. The authorizing committees have yet to agree on any significant reforms, but have indicated their inclination to reauthorize the immigrant investor program, so we expect a straight-line reauthorization. There have been hearings and rumblings from the Capitol Hill on refocusing the program, but no consensus has been reached as yet.

    State Children’s Health Insurance Program, or “S-CHIP”

    S-CHIP is basically Medicaid for kids and pregnant women. It is the very definition of a “must pass” bill. It needs an extension or reauthorization or it will partially shut down leaving millions of women and children potentially without insurance. Because passage requires 60-votes, there is an itty-bitty chance it is used as a bipartisan catalyst to tweak (but not repeal or replace) ObamaCare due to the outcry over the dysfunctional individual insurance markets.


    A Potpourri of Other Issues

    Aside from the National Flood Insurance Program and EB-5 immigration program, other programs that expire without re-authorization include the Federal Aviation Administration (which has some controversies around privatization) and FDA User Fee bills.

    Raising the Debt Ceiling – a.k.a. Giving Treasury the Authority to Pay the Bills We Owe

    The temperature in the room during the debates on the above could well foreshadow the degree of risk during the volatile debt ceiling battle. The ceiling was officially triggered on March 15, after which the Treasury began using extraordinary measures (EM) to prevent technical default scenarios. The Sept. 29 date mentioned above is the date on which EM will be exhausted. The chief obstacle in raising the debt ceiling (or, as Congress did last time, simply suspend it) is populist optics in explaining that a debt ceiling vote merely allows the government to pay bills it has already incurred.

    Opposing a debt ceiling hike is either a political shot across the bow (as then-Senator Obama did in ’06) or a painful party exercise, given that lots of Republican lawmakers have sworn to never raise the debt ceiling. The good news is that Democrats historically, for the most part, have been willing to vote for a “clean” debt ceiling raise, which means no policy extortion. This is why the House will likely need a majority of Democrat support (because the GOP will lose nearly half their caucus) and the Senate will need dozens of Democrats to overcome the 60-vote threshold, as there could well be substantial GOP defections in the Senate as well.

    Recent events, such as Trump’s rally in Phoenix, do not help calm the waters. During his closing, the President reiterated his dedication to immigration and the Wall by saying, “Believe me, if we have to close down our government, we’re building that wall … One way or the other, we’re going to get that wall.”

    Not Just for DC: States Can Shut Down Too. Two states – New Jersey and Maine – faced brief government shutdowns over the July 4 holiday weekend after lawmakers failed to approve spending plans by the July 1 start of their fiscal years. But of course the brinksmanship ended and both states’ governors ultimately signed their legislatures' proposals within three days. Recall the infamous Chris Christie beach photo during the shutdown.

    What’s the Debt Limit Fight All About? Before 1917, each loan issued by the Treasury required a separate authorization from Congress. It wasn’t until World War I that Congress changed the law to allow the Treasury to sell war bonds as needed, provided that bond sales didn’t exceed a specific amount. Once that amount was reached, Treasury must receive permission from Congress to issue bonds to whatever new level Congress sets, thus giving birth to our national debt limit.

    Our Expected Outcomes

    Funding the Government: Look for a short-term extension of government operations – as mentioned above – a CR, along with key programs with authorizations that expire September 30. There is simply too much to do now that Congress has postponed decisions about the fiscal 2018 budget and appropriations for the new fiscal year. Given that the House has only 12 days in session before the fiscal year-end and the escalating tensions in Washington, a brief government shutdown should be considered, if not priced into assumptions.

    Raising the Debt Ceiling: Congressional leaders have said they intend to raise the debt limit without political drama or roiling financial markets. We remain somewhat skeptical. Democrats have been rewarded by their base (through campaign contributions) for refusing to go along with Republican legislation. If so inclined, Majority Leader Chuck Schumer (D-NY) could withhold Democrat support for the 60-vote threshold bills[1] – such as Continuing Resolutions and program extensions – and extract major concessions from the GOP since a bipartisan vote would be necessary for passage.

    Seeking to calm anxious markets, on August 21 Senate Majority Leader Mitch McConnell (R-KY), with Secretary Steve Mnuchin in tow, commented, “there is zero chance – no chance – we won’t raise the debt ceiling.” The current debt limit – which was surpassed already in March – stands at $19.8 trillion. At 75% of GDP, federal debt held by the public (which excludes bonds held by Social Security or Medicare trust funds) is now at its highest level since shortly after World War II. We expect the debt ceiling to be increased, but only perhaps after some routine Congressional theatrics.

    What about Those Big Ticket Items like Tax Reform?

    As we wrote on August 8, shortly after the November Presidential election, the mathematical path was determined to move healthcare first via the first reconciliation bill (the FY 2017 Congressional Budget bill). Due to the spending involved in the existing health law, removing the taxes and spending associated with it could result in a lower “pay-for[2]” to offset the massive tax cuts promised by Republicans during 2016.

    As calendar year-end approaches, neither healthcare nor tax reform are likely to be addressed at all – let alone any wholesale reforms. There simply isn’t enough time to run it through the full committee process that allows for the “full and open debate” that many on both sides have demanded since the election. To wit: after recess, there are only 32 legislative days in 2017 that Congress will be in session.

    So What’s the Timing on Tax Reform?

    Given that the failed healthcare effort fell short of the 50 votes needed in the Senate for passage, any consideration of tax reform under the same 50-vote threshold would require a 2018 Congressional Budget. As a refresher, attaching both health care and tax reform to a budget bill makes it “privileged” and therefore requires only a simple majority for passage. Health care has already come and gone (via the 2017 Budget Reconciliation bill) and for tax reform to be considered, it would need to be attached to the 2018 Budget Reconciliation bill. The issue here is that we have no census on what that bill might look like – conservatives are unhappy with ceremonial budgets (like the one used for the health care vehicle) and want for push to more “teeth” to control federal spending. As a result, party consensus has been elusive, and so, too, has been the bill to carry the tax reform package.

    Speaking of the tax reform package, we are still waiting for the final version. Please see below for our prognostication on what it might possibly look like. We fully expect tax reform to be fiercely debated this Congress, although the outcome is less certain in the wake of cross- and inter-branch squabbling, not to outright mention R-on-R aggression. See The New York Times’ latest on Trump vs. McConnell here and Trump vs. others here.

    For a quick and dirty “explainer” on how DC logic makes no sense outside of DC, please see an interview with Budget Director Mick Mulvaney (who speaks rather swiftly).

    Simply put, we expect a consensus on tax reform to emerge in both houses prior to year-end, and full consideration can begin in earnest after Congress returns the first week of January. This assumes, of course, the White House is behind whatever the consensus plan becomes. As of now, our assumptions for the end game on the new corporate tax regime are the following:

    • C-corp marginal tax rate between 22-26%;
    • Immediate expensing for assets with useful lives less than 20 years (i.e., commercial real estate would not be subject to immediate expensing since its useful life is considered 39 years; conversely, leasehold improvements are 15 years);
    • Eliminating the interest expense deduction remains very much in play; it is a huge pay-for and highly desired for its revenue impact to lower overall marginal tax rates; and
    • Eliminating 1031 Like/Kind exchanges is similarly desired – savings (revenue) estimates could be as high as $200 billion over ten years.

    Given the fluidity surrounding fiscal year-end and the never-ending drama and media cat-nip coming from the Trump White House, all bets for major reforms should be hedged. This might well include trading a massive tax reform for a more modest tax cut (that would likely sunset in 10 years) just to save political face and claim a small victory. Beware: midterm election season will be in full tilt Q1 2018.

    Please contact Marty Schuh for further information.

    [1] 60-vote bills are considered in the ordinary course of legislating – that is say NOT “privileged” bills which are subject to a simple majority, such as budget bills or Federal nominees. Health care and tax reform could be considered “budget” bills on account of their inclusion in the annual Congressional Budgets under a process called “reconciliation”. Please see my August 8 blog post on a deeper dive between the bill types.

    2 A “pay-for” is simply a revenue offset to “pay-for” either an increase in spending (e.g., more outlays for defense) or a decrease in revenue (tax cut) so as not to affect the total annual deficit.

  • We are often asked, “Why is Congress so preoccupied with health care and why can’t they do anything else?” Indeed, the healthcare debate has largely held the broader agenda hostage while Leadership bends policy in search of supporters.

    The short answer is they had to address healthcare because they ran on precisely that promise, nationwide for seven years. Just as importantly, Republicans also ran on tax reform.  However, lowering tax rates, either individually or corporately, costs money, and spending government money is anathema to the GOP’s core beliefs. 

    Therefore, Republicans took the approach that reforming healthcare first would save the government coffers money, and that savings could be used to “pay” for the cost of reducing tax rates, therefore leaving the Federal deficit neutral after two major reform efforts.

    To quote the Princess Bride: “there is too much, let me sum up:

    • Republicans want to lower corporate tax rates from 35% to 25% or 15%, a change that will cost north of $2 trillion to Federal coffers;
    • The degree of the tax rate cut depends greatly on how much is spent (or not spent) on healthcare subsidies (not to mention that the Republicans have been running on repealing Obamacare since 2010); and
    • We are facing a massive fiscal cliff in roughly two months with the confluence of a looming government shutdown and the risk of hitting the debt limit.

    To put a bit of detail on the fiscal cliff:

    • The FY 2018 Federal budget is due by October 1st, or the government shuts down.
    • Treasury Secretary Mnuchin has stated that the debt ceiling will be reached by September 29th.Absent Congressional action to raise the debt ceiling in time, the government will not be able to pay its bills.

    When the full Congress returns after Labor Day, it has given itself a total of 12 legislative days to address these two very thorny issues that make up a preponderance of the fiscal cliff. The timing here makes it highly unlikely that healthcare and tax reform will be addressed in full by year-end. In what follows, we provide our views as to how and why healthcare reform efforts failed.  Why the Senate was unable to get the 51 votes necessary to reform healthcare? What happens now, and why exactly do we keep hearing about a 60-vote threshold in the Senate to move major pieces of legislation – what’s the difference?

    The Senate and the House of Representatives – Deliberative Bodies with Different Rules

    In the Senate. Most readers know enough about Congress to recall the old adages about the ‘Upper Chamber’ and the ‘World’s most deliberative body’ being ascribed to the Senate due to its reasoned, thoughtful and non-reactionary approach to lawmaking. The current Senate rules permit a senator, or a series of senators, to speak for as long as they wish and on any topic they choose, unless three-fifths of Senators (currently 60 out of 100) end the debate. This is called “invoking cloture” under Senate rules. Times were not always so contentious as they are today, however. In the 47 years of the filibuster era until 1964, cloture was invoked only five times. Conversely, these days, it seems nearly all bills of measurable substance are subject to a filibuster for political reasons.

    However, the ability to invoke cloture has evolved over time, most recently through the nomination (and confirmation) of Supreme Court Justice Neil Gorsuch in April.

    Certain bills are not subject to the Filibuster Rule, and therefore cannot be filibustered. (Fun fact: the term filibuster is from the Dutch word for “pirate”.)

    • Reconciliation. The first of these bills is known as “reconciliation”. Reconciliation, a procedure created in 1974, refers to a process established in which Congressional committees reconcile spending in programs within their jurisdiction to the annual Congressional Budget for a given fiscal year (Oct. 1. through Sept. 30). In brief, the budget process begins with adoption of a Congressional Budget resolution that sets overall funding levels for the government. Note that the Congressional Budget resolution is passed by simple majority in each house, is not signed by the President, and does not carry force of law.
    • Congressional Review Act. The second type of bill considered outside of the filibuster is the Congressional Review Act (CRA). We have written at some length about the bills offered under the CRA – meeting success a dozen times this Congress. These bills are subject to time limits and are used to overturn regulatory rules within 60 legislative days of finalization. (Just last week, a CRA bill was introduced to overturn the controversial Arbitration Rule issued by the CFPB.)

    In the House
    . Conversely, the House law factory is like a live-debate poll – produces near instant results and usually not a good indicator of ultimate outcomes. Except this time. The healthcare debate in the House was excruciating for its lack of consensus and intra-party squabbles on big policy decisions affecting millions of insured. In the end, it was a leading indicator for the same squabbles that unfolded in the Senate during July and culminated late on Monday night, July 17. That was when Senate Majority Leader Mitch McConnell (R-KY) effectively killed the Republican attempt to ‘repeal/replace Obamacare’.

    Healthcare Replay – How It Unfolded

    These days, Republicans enjoy single-party rule, seemingly able to pass bills at will with a willing signer in the White House. And, luckily for them, they had two reconciliation bills at their disposal (given that a budget was never passed last year) to squeak through their agenda with only 51 votes, not the usual 60.

    As a refresher, the Democrats passed their health bill in 2009 with 100% of their caucus voting in favor, while all Republicans who were present voted against. Democrats controlled 60 votes in the Senate in 2009. Conversely, the Republican caucus of 2017 is more ideologically-driven on an individual member basis, so 100% party alignment is not a given on any particular vote. That was the case this time around.

    The [supposedly] annual Congressional Budget was not considered or passed during the past Congress. The current Congress passed a budget for 2017 in January retroactively (since we were already passed the fiscal year start) and inserted reconciliation instructions to include health care provisions, thus rendering those provisions subject to only a 51-vote threshold, rather than the usual 60. We are currently in FY 2018 and this year’s budget could [conceivably] be passed shortly with instructions for reconciliation for tax reform measures – again, subject to the 51-vote threshold.

    Shortly after the November Presidential election, the mathematical path was determined to move health care first via the first reconciliation bill (the FY 2017 Congressional Budget bill). Due to the spending involved in the existing health law, removing the taxes and spending associated with it could result in a lower “pay-for[1]” to offset the massive tax cuts promised by Republicans during 2016.

    The Math: The Congressional Budget Office (CBO) estimated that government would collect $41.3 trillion in taxes over the next decade. An earlier version of the Republican plan to repeal and replace the Affordable Care Act would have reduced that income by about $1 trillion – due to repealing the taxes associated with the Act. The GOP plan would have offset the tax revenue loss by cutting spending on health subsidies and entitlements. All totaled, the GOP plan more than offset the liability created by repealing the taxes – they lowered spending by an additional $115 billion ($1.15 trillion total).

    Again, why is this all so important? Because simply lowering the corporate tax rate from 35% to 20% – as Speaker Paul Ryan (R-WI) has proposed – could reduce Federal Government revenue by an estimated $2.75 trillion over 10 years. If Republicans insist on not financing tax cuts through deficit spending, their commitment to “revenue neutrality” means raising taxes or cutting spending somewhere else (in this case, healthcare).

    President Trump is famously quoted as saying “nobody knew that health care could be so complicated”. Apparently, the calculus has changed in the seven years since the health law first passed. Americans have grown accustomed to certain parts of the law, and Republicans have heard this directly at angry town-hall meetings back home. Given the public backlash, consensus has grown elusive and thus we are ‘stuck’ in the health care ditch.

    The final attempt at some type of repeal failed in a dramatic Senate vote during the early morning hours of July 28, with Senator John McCain (R-AZ) casting the final “nye” vote, delivering the  nail in the coffin. McCain said he remained unconvinced that the bill he was voting to go to conference would be to his liking without significant modification during a legislative conference where the Senate and House plans would be merged into a compromise bill. After the stunning defeat to Senate Majority Leader Mitch McConnell (R-KY) and a major blow to the Republican brand, the party will now focus its attention toward tax reform.

    Tax Reform and the Potential Vehicles for Legislation

    According to the original post-election plan, a second reconciliation bill (the FY 2018 Congressional Budget) was pegged for tax reform with an initial deadline set prior to the original August recess (beginning July 28). Budget reconciliation is an extremely cumbersome and complex procedural tool that sets overall funding levels for the Federal Government.  Budget reconciliation requires an overall budget with specific instructions that lay out parameters within which the tax levers may be adjusted (or ‘reconciled’).

    Under the above scenario, just two bills –  (the Congressional Budgets for FY 17 and FY 18) (passed with simple majorities via reconciliation) – could have set the table to accomplish many of the campaigned-on promises during the 2016 elections. At the beginning of the year, the two reconciliation bills could have moved quickly and sequentially. Bear in mind the following four actions are chronological, but not necessarily sequential.

    It is possible to have 3) and 4) ultimately pass without 1) and 2) being passed– it would just lower the scope of 4) by roughly $1 trillion.

    1. FY 17 Congressional Budget (the so-called "skinny budget" passed in January – well after the fiscal year started – along party lines) contained the necessary instructions for health care repeal/replace, but a serious policy document it was not – merely a means to an end.
    2. FY 17 Reconciliation Bill (this is/will be the vote on the “reconciled” Budget bill). This was the vehicle for healthcare reform. (The House passed its repeal/replace on May 4; the Senate failed on July 28).
    3. FY 18 Congressional Budget (House Budget Committee passed by voice vote, next step is full House vote after recess).
    4. FY18 Reconciliation Bill. This could/will be the vehicle for tax reform. Until the FY 18 budgets pass both the House and Senate, we won’t know the scope and size of tax reform. Much depends on the reconciliation instructions embedded in the FY 2018 budget. If committee instructions allude to “Revenue neutral” the end product could produce permanent tax policy[2]. If the instructions have targets in the billions (not trillions), we believe the scope for tax “reform” will be merely a “tax cut”.

    These four bills are all under the “optional” reconciliation track – and not technically “must-pass” (that is to say bills essential to government operation, such as children’s health insurance expiring Sept. 30). If Republicans are indeed keen to avoid getting blown out in the midterms next November, they will use all influence available to make good on at least one of their campaign platform issues, and tax reform seems to be where the GOP’s bullseye currently lies.

    Governance Will Impede the Path to Tax Reform

    While Congress bickers about health care, budgets, reconciliation instructions, and the like, there is that ‘inconvenient’ parallel track of actual governance (i.e., keeping the .gov lights on).

    Since Congress hasn’t been able to agree on annual appropriations levels for the Federal agencies it is supposed to fund, it will need to pass a stop-gap spending measure by October 1, likely in the form of a FY “Continuing Resolution (CR).  The CR is conveniently known as a Congressional “punt.”  In general, CR’s continue to fund the government on a go-forward basis at the previous year’s levels.  CR’s can be for any specified amount of time, and they can also include special instructions to change funding levels for specific portions of the government (if agreement can be reached).  In this case, we are likely to see a CR for FY 2018 considering there are 12 legislative days to handle the issue once Congress returns from August recess post Labor Day. 

    Congress will also need to raise the debt ceiling – likely by October 1st as well.

    Unlike reconciliation, these pesky “governance” bills are subject to the 60-vote threshold in the Senate.

    Congressional Fallout – Expectations for the Remainder of 2017

    Absent any legislative breakthroughs or intervening national unity event (usually not a pleasant thought given what it takes to unite our country these days…), we don’t see how this mess gets untangled, given the current rate of legislative in-efficiency. This was a pivotal week in Washington. Will the President now start holding campaign rallies in Congressional districts over the recess to cajole wayward members from his own party?  

    Is our only hope the proverbial ‘grand bargain’ against mutually assured destruction? This has been under discussion in DC for nearly the whole Trump presidency. With the real potential for a fiscal cliff at fiscal yearend and a host of must-pass bills still unseen, let alone formally considered, cynics in the beltway have been quietly speculating on the endgame for months. Our take is more of the status quo – a series of stop-gap, kick-the-can measures to keep the lights on, our debt investment-grade and the kids’ and flood-prone properties insured. Not to say that a ‘grand bargain‘ couldn’t happen, but we think the odds of that just before a contentious election year are on par with Phil Mickelson winning the PGA Tournament (currently 41:1).

    Next week we will follow up with “Part two” of this article, and address how the issues affecting our industry will be addressed, including flood insurance, HVCRE, GSE reform, the Choice Act and regulatory reform efforts.

    1 A “pay-for” is, simply, a revenue offset to “pay-for” either an increase in spending (e.g., more outlays for defense) or a decrease in revenue (tax cut) so as not to impact the total annual deficit.

    [2] If the FY 18 Budget is passed with reconciliation instructions on a “revenue neutral” basis, the policies will stand until later replaced or repealed by Congress. Known as the “Byrd Rule”, any reconciliations passed that contain provisions that are not at deficit-neutral or deficit-reducing are sunset after ten years (the budget window). These are adjudicated before the bill is considered in a process known as a “Byrd bath”.

  • A rare public dispute is playing out between two top financial regulators over a recently finalized regulation. Acting Comptroller of the Currency Keith Noreika has publically called on Consumer Financial Protection Bureau (CFPB) Director Richard Cordray to delay its final rule on mandatory arbitration clauses. Noreika has raised concerns in a number of letters that the rule, which prevents banks from using arbitration clauses to ban class action lawsuits, would threaten banks’ safety and soundness.  Cordray has dismissed those concerns. While the substance of the rule doesn’t affect CRE finance, the dispute is a case study that pits a Trump appointee against an Obama-era regulator and offers a view into the way in which a final rule could be challenged by someone without the direct authority to do so.

    We here at CREFC have maintained that changes in regulatory leadership will be key to the Administration’s goal on reducing regulator burden.  This spat is a public example of those clashing regulatory worldviews. With more Trump appointees in the pipeline, will these spats become more commonplace? Looking backward, the Fiduciary Rule remains in limbo while the Department of Labor gathers additional information. Looking forward, the Volcker Rule, amongst others, could prove to be a subject for debate, as well. Let’s take a look at the financial regulatory system, this dispute, and how it might play out among other regulators.

    The Financial Services Industry Has Many Regulators with Broad, Overlapping Authority

    The Financial Stability Oversight Council (FSOC or Council), which is charged with overall oversight of the financial system and industry, has representatives from nine different federal agencies: Treasury, Federal Reserve, Office of the Comptroller of the Currency (OCC), CFPB, the Securities and Exchange Commission (SEC), Federal Deposit Insurance Corporation (FDIC), Commodity Future Trading Commission (CFTC), Federal Housing Finance Agency (FHFA), and the National Credit Union Administration (NCUA). Each regulator’s jurisdiction is defined by statute, but it can vary based on the entity regulated (e.g., the OCC regulates national banks and NCUA regulates credit unions), but it also varies on subject matter (e.g., CFPB writes rules on credit cards; SEC writes rules on securities). As a result, many rules are joint efforts involving many regulators, (e.g., Credit Risk Retention has six: Fed, FDIC, OCC, SEC, FHFA, and HUD). But even where regulators don’t have a formal role in a particular rulemaking, communication and cooperation often still occur.

    In the case of the arbitration rule, the CFPB is the sole regulator, as it has a statutory mandate for rulemaking and jurisdiction on the subject.  Acting Comptroller Noreika is raising concerns based on his agency’s broad safety and soundness authority over the federal banking system and “potentially ruinous liability” through frivolous class-action law suits. This argument is a shift from the conventional wisdom of safety and soundness; opponents of regulation have raised the “safety and soundness” mandate that gives banking regulators vast authority with few constraints. While that authority is usually employed to make regulation, here it’s being used to [potentially] block a regulation.

    Independent Regulators Don’t Answer to the President

    Most of the financial regulators are independent agencies, which insulates them, to some extent, from control by the executive branch and the President (mainly that they cannot be fired without cause by the President). Many independent agencies also have funding sources outside the congressional appropriation, which can soften the threat of budget cuts. The basic concept is to remove politics from the regulation of the sector, though the effectiveness has been increasingly criticized.

    Both the CFPB and OCC are independent agencies. Director Cordray cannot be fired by President Trump without cause (though this restriction is subject to ongoing litigation), and the CFPB has control over its funding. The OCC is an independent agency embedded in the Treasury Department, but the Treasury Secretary is specifically prohibited from interfering with the OCC’s regulatory, enforcement and supervision process. In this case, the independence prevents the President or another executive branch official from taking direct action in making a final decision.

    Another feature of the OCC and CFPB is that they are both led by a single appointee rather than a commission. That factor could be fueling the dispute as well; a Federal Reserve Governor could speak out against a rule, but a formal action would take a board vote.

    FSOC Can Set Aside the CFPB Rule

    Despite the CFPB’s independence from Congress and the President, the FSOC does have the ability to delay or set aside a final CFPB regulation if an FSOC member petitions the council and 2/3 of the voting members agree. 12 USC 5513.  If the OCC were to officially petition FSOC, Treasury Secretary Steve Mnuchin would have the power to temporarily prevent the regulation from taking effect until FSOC makes a decision (with a maximum delay of 90 days). The power is unique to CFPB regulations, though FSOC can resolve jurisdiction disputes among the member agencies on other issues. Noreika’s citation of the safety and soundness aspects seem to lay the groundwork for an FSOC consideration of the rule.

    Even if Noreika sought to delay or set aside the rule through FSOC, success is unlikely, given that 5 out of the 10 members currently are Obama appointees, which would leave the Council short of the 7 necessary votes to act.

    Congress Can Step In

    The Congressional Review Act (CRA) will likely determine the fate of the arbitration rule. You may recall that the CRA allows Congress to use expedited procedures to disapprove final rulemakings and regulations. The key is that only 51 votes are needed for passage in the Senate, which removes the potency of a filibuster threat, which would require 60 votes. Once passed by both houses, the President has to sign it.  The CRA has been a very popular tool for the 115th Congress and President Trump to rollback 14 Obama-era regulations. Since its creation in 1996 and prior to recent history, the CRA had only been successfully used once.

    As I’ve previously written, the CRA could be an effective tool for critics of regulation made by independent agencies. While Congress can’t use the CRA to rollback regulations on the books, it can serve as a backstop for new regulations that do not enjoy majority support in Congress or by the President. With most other regulations, the President has greater power to craft the regulatory and deregulatory agenda through his executive agencies.  As discussed above, that’s not the case with most of the financial regulators.  Thus, the CRA is a sort of last resort to stop a new regulation from an independent agency.  Of course, Congress and the President can always pass a new law to nix any regulation (new or old), but that law would likely be subject to the 60-vote threshold (needing 8 Democrats) to break a filibuster in the Senate. Even in the more collegial Senate, bipartisanship has become an increasingly difficult achievement.

    For the arbitration rule, an effort is underway already to use the CRA to scrap the rule. The effort enjoys support from the relevant chairs in both bodies, but the crucial number will be whether 50 senators will support nixing the rule.

    Click here for my previous post on the CRA.

    Regulators Don’t Serve for Life

    Even if Congress decides not to act on this regulation or others, the clock is ticking on many regulators’ terms of office. CREFC maintains that leadership changes at the agencies likely will have the greatest effect on regulation, supervision, and policy.  Acting Comptroller Noreika’s actions are an example of that shift, as former Comptroller Thomas Curry did not raise any public objection with the rule. The shift will continue as the Trump administration fills vacancies at the Fed, the SEC, and the FDIC. Director Cordray’s term is up in July 2018 (there are rumors he may leave early to run for Governor of Ohio). Disagreements among regulators may not be as publically polarized as this instance, but it highlights the impact a new President can have on financial regulation.  

  • On July 7, the Federal Housing Finance Agency (FHFA), the regulator and conservator of the government-sponsored enterprises (GSEs), proposed its single family and multifamily housing goals for 2018-2020. The statutorily-required benchmarks were first introduced in 1992 and substantially revised when the conservatorship was established in 2008. For both single-family and multifamily, the proposal structures the goals in terms of low-income and affordable housing, with a variety of breakdowns and sub-goals. The proposed goals cover low-income annual units for 2018-2020, though FHFA has the authority to adjust the goals as market conditions fluctuate. FHFA is proposing a slight increase from the current Low-Income Housing goals.  The FHFA is seeking public input on their proposal, and comments are due by September 5, 2017.

    CREFC's full analysis is attached.    


    FHFA Benchmarks (07.14.17 FINAL).pdf GSE Benchmark CREFC Analysis

  • On Friday, the White House announced that President Trump would nominate James Clinger to chair the Federal Deposit Insurance Corporation (FDIC). Clinger will be nominated first to fill a vacant director position (Jeremiah Norton resigned on June 5, 2015), and then nominated to serve a five-year term as Chairman upon Mr. Gruenberg’s term expiration in November.  By all accounts, Clinger, who had served as counsel to Republicans on the House Financial Services Committee since 1995 (with a break from 2005-1007), is a considered a quiet and industrious professional, who aided in both the development and the proposed reforms of the Dodd-Frank Act (DFA).

    The press generally argues that his appointment would bring a rollback of the DFA much closer to reality, which I believe is largely untrue. Even the Financial CHOICE Act (FCA) leaves much of the current regulatory infrastructure in place. While it rearranges thresholds, governance frameworks and rulemaking processes, it leaves the most disruptive aspects of 21st-Century regulation, capital and liquidity rules, effectively unchallenged. Remember that FCA offers a voluntary trade-off to larger banks subject to complex capital rules: hold enough capital and skip stress tests and other complex capital rules. The trade-off, however, is generally considered to be unattractive, as the FCA alternative would actually materially raise the regulatory capital requirement for these institutions.

    It is also highly likely that most of the rollback proposed in the FCA simply will not happen. The Senate, with its pesky 60-vote threshold (meaning Republicans must not only hold all of its votes, but also find 8 Democrats in order to move legislation), likely will only consider bite-sized pieces of the FCA, and the regulators, the main actors in this scene, will likely maintain the vast majority of the Basel regime that is currently in place. Again, the off-ramp offered in the FCA is more expensive and there is little appetite amongst the regulators and the industry to undo the risk sensitivity that has been so painstakingly built into the system since the crisis. 

    Furthermore, the Department of the Treasury’s first (of an expected four) report on financial regulatory reform largely echoed this overall theme, as it suggested more tweaks to the current regulatory landscape in lieu of a complete overhaul (see CREFC’s analysis here).

    Most importantly, the banking agencies have broad statutory authority, predating Dodd-Frank (e.g. safety and soundness), to create rules and enforce standards.  On the enforcement side, for example, the elimination of the Volcker rule would not necessarily end regulatory pressures on trading operations, though suggested revisions would go a long way towards streamlining compliance and trading rules. Even with significant changes at the top of the agencies and potentially legislatively as well, the idea that enforcement models would do full 180s is improbable.

    Finally, Clinger and the FDIC should be considered veto votes across the three banking agencies (Fed, FDIC and OCC). Community banks are important on the margins, but they represent roughly 20% of the US banking activity at any given time. The big banks are still our largest source of credit, directly or indirectly. If we think the FCA represents the regulatory doctrine of Clinger and the other regulators in waiting (Randy Quarles (Fed) and John Otting (OCC)), then we can still assume that the primary credit constraint, Basel III, will remain in place.

    To be sure, CREFC staff are hopeful that in isolated cases the regulators may follow through on clarifications and minor revisions, as in the case of the High Volatility Commercial Real Estate (HVCRE). The Treasury’s banking reform study published on June 12 underscored the need for rationalizing some of the more extreme and disruptive aspects of our current regulatory framework. It also reiterated the execution risk involved, with multiple layers of legislative, rules-based and enforcement changes necessary to even marginal reforms and relief. While the opportunity for change is materializing more so than in the last ten years, success will require concerted and effective advocacy…and some luck.

    To See CREFC’s position on HVCRE, see (letter we signed endorsing) here, and bill here.       

    David McCarthy assisted in writing this article.

  • Senate Banking Committee Chairman Mike Crapo (R-ID) said yesterday he's more optimistic about gaining bipartisan support for housing finance reform than on some of the more controversial areas of financial deregulation, such as the CHOICE Act.

    “Housing finance is one of those areas that has greater potential than many of the others,” Crapo said, speaking at a Women in Housing and Finance event in Washington (CREFC’s Christina Zausner is a member of the group). Crapo also alluded to a separate economic growth package that could include modest regulatory reforms. This likely stems from Crapo and Ranking Member Sherrod Brown (D-OH) convening a hearing in March that sought to create legislative vehicles that would “enable consumers, market participants and financial companies to better participate in the economy.”

    Crapo also said there was a “heavy, busy agenda” in the Senate, including government funding, health care, tax reform and Administration nominations. His expectation was that any other legislation would be pushed into late fall and perhaps into next year.

    On the ancillary banking reform initiatives, Crapo referred to one of former Federal Reserve Gov. Daniel Tarullo's parting speeches, in which he made recommendations including raising the $50 billion threshold for enhanced prudential standards, easing stress test requirements, simplifying the Volcker rule and streamlining small-bank capital rules.

    In addition, he said he met with Treasury Secretary Steven Mnuchin Thursday morning. No detail on the topics of their conversation was shared.

  • Step-In Risk (SIR) did not fade away as the industry had hoped. It is back and ready to become policy now that the Basel Committee on Banking Supervision (BCBS) published its second consultative document (CD) on March 15.

     What Is SIR?

    SIR is the second derivative of reputational risk. Regulators believe that where there is reputational risk, there may also be SIR. In the case of CMBS, SIR occurs if sponsor bank choses to provide economic support to sponsored, but unconsolidated entities. For those who are not familiar with reputational risk, it encompasses all things that could inflict damage to a bank’s franchise, but some specific examples are public regulatory actions (such as cease-and-desist orders and fines), litigation, and….widespread defaults of bonds.   

     Why SIR Is Out of Step with Other Policy Themes?

    Improving economic growth is an issue both Republicans and Democrats see eye-to-eye on in the legislature and reducing regulatory burden is one of the solutions that some are considering. With these themes in mind, the addition of SIR by the BCBS to its agenda on top of a regulatory framework that already addresses reputational risk is dissonant with the prevailing themes of the day.  

     What Does the CD Require?

    The SIR CD is simply another self-assessment requirement. It does not assess automatic capital and/or liquidity charges, but it does hold them out as a potential remediation if SIR is deemed to be a material risk.  

     Why Do We Care?

    There have been previous supervisory exercises that begin, much like SIR, as requests for data and analysis. Sometimes the regulators’ assessments of these requests turn out differently than the banks’. It is fair to say that the Fed-led stress tests and capital reviews start out as requests for information, and end with the banks and the regulators disagreeing on the facts. In a worst-case scenario, these ‘exercises’ could trigger additional capital and liquidity charges for off-balance-sheet CMBS.

    In the case of the second SIR CD, the definitions of the risk factors seem so broadly written that SIR could be deemed to be present based on relatively little - or even no risk - of such an event. The question of investor appropriateness, in particular, could be an issue in the case of CMBS. Though CMBS are sold to qualified investors, the reference in the CD (section 3.8 on page 10) indicates that the determination as to the appropriateness of the investor is to be based on an investor’s “risk appetite”, which is an unspecified concept without legal underpinnings. 

     What Comes Next?

     If all goes according to plan, the BCBS will finalize its requirements quickly and then home country regulators then decide whether or not to tailor and promulgate rules for their national jurisdiction. In the U.S., all capital rules promulgated by the Federal Reserve, FDIC and OCC must be put through the notice-and-comment process so the industry can provide feedback. The BCBS is targeting 2019 for implementation.

     CREFC Advocacy

    CREFC signed an industry letter when the BCBS issued its first CD on SIR in December 2015. We and other trade associations argued then that the current regulatory framework is more than sufficient to surface material risks and to counterbalance them with capital and liquidity requirements.  CREFC is working with CREFC Europe, the Real Estate Roundtable, and possibly other trade associations to file a comment letter for the second CD. To hear more about the effort and/or to provide feedback, please contact me at czausner@crefc.org or 202-448-0851. 

  • As we alluded to in last Friday’s (03-24-17) Week in Washington, the House of Representatives was stuck shy of the majority of votes needed on a bill to repeal and replace the Affordable Care Act (aka ‘Obamacare’).  The vote was canceled – not to be rescheduled. The President not soon after declared that particular effort dead and said he was eager to move on to tax reform.

    The road to Friday’s ultimate rebellion was the antithesis of what Republicans campaigned on in the wave election of 2010, and again in 2016. They said Obamacare was secretly written in the back room by party leadership, brought to the floor hastily, lacked a real Congressional Budget Office (CBO) score for cost evaluation and was unfamiliar to both the Congressmen voting and the constituents they represented. In the end, the Republicans unwittingly copied the Democrat playbook almost to a tee. They violated the very same mantras they ran on in 2010 and that proved a bridge too far for more than two dozen of the members, and likely many more had a true vote of conscience been taken.

    In the end, it was a huge setback for President Trump (pardon the use of his favorite word) and the Speaker. Not only was it a stinging symbolic defeat on one of his signature issues – indeed, one of the caucus’ signature issues – it was very much a key component to his pro-growth tax reform plan.

    So, how is health care repeal a key element of tax reform? At its core, Obamacare relied on a series of fees (or ‘taxes’ as the Supreme Court later ruled) to fund the subsidies required to assist the low income purchase of health insurance or to support state Medicaid programs. Initially, Speaker Paul Ryan (R-WI), one of the chief architects of tax reform, had the repeal of the Affordable Care Act scored as ‘saving’ about $1 trillion over 10 years. This re-arced the so-called ‘tax baseline’ for the purposes of the tax reform debate. Since the party wanted to lower the corporate tax rate 10 percentage points, they needed that “pay-for” (along with the highly controversial border adjustment tax, or ‘BAT’) to come up with the $2 trillion that would allow tax reform to score as revenue-neutral over 10 years.

    Without the repeal of Obamacare, Speaker Ryan now has a $1 trillion hole to plug if he, the President or the caucus insist on a revenue-neutral package. We suspect those leadership-aligned, moderate Republican voices would quickly become recalcitrant fiscal hawks for fear of being ousted in a primary next year. This brings President Trump to a fork in the road: Does he consolidate the party and pass large reforms on party-line votes, or look past the 25 or so House Freedom Caucus members hell bent on voting ‘no’ to everything and begin working with Democrats?  Recent statements suggest the latter.

    As the nation’s dealmaker-in-chief, Trump can fulfill one of his campaign slogans by reaching across the aisle and grabbing 30-40 moderate Democrats from states very much in play in 2018 and 2020. It appears as if he may use infrastructure funding as a means to lure Democrats to the table on tax reform.

    To be sure, obstacles are in clear view: the Supreme Court vacancy, a two-week April recess, government funding that expires April 28, another budget deal needed in May and a host of nominees to push through the Senate under adversarial and time-wasting rules. What could usher in this utopia of bipartisanship? A bill that unites members by something other than party affiliation…

    Flood insurance is the next priority on the House Financial Services Committee calendar (the program expires September 30). We were told just days ago that the bill is nearly complete and almost ready for mark-up. And, during the last hearing we heard encouraging words from the Chairman for a multi-year reauthorization. Readers will recall the Chair’s less-than-enthusiastic words at the start of the terrorism insurance reauthorization effort. Since the Chairman is coming at this effort from a pro-reauthorization stance, we are bullish for an on-time renewal ahead of expiration.

    Could the flood bill be what breaks the dam of partisanship gridlock in Washington? We shall see, but many other efforts are increasingly dependent on Democrats voting with the majority to push signature priorities over the finish line, such as infrastructure, tax reform and immigration reform. 2017 promises to be a whirlwind ride that’s only just getting started.

  • On March 13, 2017, Thomas Hoenig, the FDIC’s Vice Chair, formally introduced an outline of his plan for revising the regulatory framework for banks. It includes relief for community banks and a 21st century version of the Glass-Steagall Act, as well as some significant relief for large banks that maintain ‘heroic’ levels of capital. For a fuller summary, see Isaac Boltansky’s (Compass Point) write-up (attached).

    When the FDIC first approached the subject in 2015, the potential for realization of Hoenig’s plan was relatively low. Then, in July 2016, the House Financial Services Committee Chairman, Jeb Hensarling (R-TX), put forward the Financial CHOICE Act, which bore unmistakable similarities to Hoenig’s plan. Still, the CHOICE Act was thought of as a messaging piece in an election year, and again, the Hoenig-Hensarling plan seemed to have only a remote probability of success.

    Hoenig’s reissued detailed blueprint, which comes one week after the Trump Administration reiterated its commitment to the Glass-Steagall concept, makes the potential for passing a capital-heavy plan for big banks seem more realistic. By all accounts, the second round of the CHOICE Act due out in the near future will retain the bones previewed in v1 and in the Hoenig plan. If the Choice Act v2 includes the 21st century Glass-Steagall piece that the Hoenig plan introduced earlier this week, there is a significant chance that a broad bank reform bill could actually attract bi-partisan support.

    In light of the fact that this regulatory reform blueprint now has a shot at becoming a signed bill, here are some questions the Hoenig plan raises:

    1.       Similarities and Differences between the Hoenig Plan and the CHOICE Act

    Both plans share similarities in their approaches to capital for large banks and relief for community banks, but there are differences in their treatment of broker-dealer activities. The scope of the CHOICE Act is broader, as it also covers regulations that apply to insurers, credit unions and rating agencies.   

    Outwardly, the differences in treatment of broker-dealer activities appear to be significant, when in fact, they may be more tactical than anything. While both plans effectively allow banks that maintain high levels of capital to be excluded from Volcker, the Hoenig model also implements the new Glass-Steagall-type division between banking and trading businesses. Hoenig’s version of Glass-Steagall requires restructuring, but both plans allow bank broker-dealers to remain under the same parent company and to manage secondary-market liquidity more flexibly than currently is possible.    

    Additionally, the CHOICE Act v1 featured a repeal of the risk-retention rule, except for residential mortgages. The Hoenig plan does not mention risk retention, reinforcing the central mission of his blueprint—bank resolvability. While the CHOICE Act also addresses the question of ‘Too-Big-To-Fail’ (TBTF), it is meant to also revitalize market efficiencies. Repeal of risk-retention is a highly partisan provision and is likely to attract aggressive debate and may antagonize Democrats.  If it remains a feature in CHOICE Act v2, there is the potential that it may be watered down (or washed out entirely) in a final bill.  

    2.       Moving from Risk-Sensitive to Simple Capital Calculations

    The Hoenig plan relies chiefly on the leverage ratio, which is meant to be a simple ratio of capital to assets. In contrast, the stress tests and risk-based capital (RBC) rely on internal capital models.  The leverage ratio is useful in that it cuts through the complexities of a large bank’s balance sheet. Some regulators see this as a way to reduce the opportunity for regulatory capital arbitrage and/or the ability of banks to hide risk factors.

    But the leverage ratio is also incomplete for both regulatory purposes and for the banks that need risk-sensitive tools to allocate capital internally to different business lines. For example, the leverage ratio treats U.S. Treasuries the same as subprime mortgages, which may be useful as a baseline measure, but hardly accomplishes the goal of ensuring that capital levels are appropriately sized to the risks on a bank’s balance sheet.

    3.       Does Hoenig Actually Mean 10%, or Is That the Starting Place

    Hoenig mentions a 10% leverage ratio requirement as the minimum level for regulatory relief from various parts of the Dodd-Frank Act (DFA). The term sheet also mentions that the “requirements should be designed to ensure that all risks are generally captured”. The capital description goes on to further describe the risks that must be covered (pointing to a continued need for an RBC regime alongside the leverage ratio) and suggests that the supplemental leverage ratio (which could add several points to the capital ratio) might be useful in covering risks that the leverage ratio does not. Even at 10%, Compass Point estimates that banks would have to raise another $507 billion in capital, most of it by the largest banks.  

    4.       What Is There to Like about the Trade-Off for Higher Capital Levels Under Hoenig’s Plan?

    The main benefits for banks that meet the 10% (or more) leverage ratio, according to Hoenig’s plan are exemptions from:

    ·         Basel liquidity requirements, including the Liquidity Coverage Ratio and the Net Stable Funding Ratio (in the proposed phase):

    ·         Most of Section 165 of the Dodd-Frank Act, including stress tests (capital assessments (CCAR) and actual stress tests (DFAST)); and

    ·         Replacement of Volcker with trader mandates.

    Bear in mind that because the banks will still have to maintain RBC functions, the costs of compliance will be reduced, but perhaps not significantly. The main place that banks qualifying for the regulatory relief would receive is likely to be a reduction in regulatory risks, which translates into fines and the ripple effects banks deal with when regulators rebuke them in public.

    5.  21st Century Glass-Steagall Resembles European Model

    As described in the Hoenig plan, 21st Century Glass-Steagall is a kinder, gentler version of the original law, because it allows broker-dealer activities to be housed under the same roof as traditional banking activities. The new version attempts to neutralize the risks of trading and other activities with a virtual firewall between the two sets of businesses, which are effectively built from the separation of legal entities, governance and other controls. The Hoenig design also bears similarities to the ring-fencing requirements promulgated in Europe since the crisis. Though this design may exist in “real life” and it shares some similarities with the good-bank/bad-bank solutions applied to failing banks, ring-fencing has never been tested. No bank that was ring-fenced while healthy has failed and undergone a resolution, which could tell us whether this approach is effective in dealing with TBTF bank failures.   

    Underlying this new age Glass-Steagall is the clear decision that the Volcker rule did not solve enough of the resolvability puzzle for large banks. Indeed, Hoenig’s plan seems to discard Volcker and replace it with trader mandates, which would presumably be internal policies that carry little to no regulatory/compliance risks.     

    Preliminary Conclusions for Commercial Real Estate Businesses: 

    While the Administration and Congress are herding their cats, the commercial real estate sector can assume the following if some facsimile of the Hoenig plan is imposed on the banking sector:

    1.       Capital requirements will increase, but the internal allocations on a relative basis most likely will not; and

    2.       To the extent that regulatory/compliance risks were driving the retrenchment of capital available to trading desks, then the reversal away from Volcker may trigger a return to deeper and larger secondary markets; but

    3.       If instead the capital burden is the greater factor in reduced capacity on secondary desks, then the Hoenig plan may cause more disruption in those markets. 

  • Trump’s nominee for Treasury Secretary, Steve Mnuchin, was questioned last week by Members of the Senate Finance Committee on how he will serve as Secretary of the Treasury if confirmed. (The Finance Committee, not the Banking Committee, will vote on the nomination).  Below is CREFC’s analysis of how Mnuchin, if confirmed, will treat issues affecting commercial real estate (CRE) finance. We base our analysis on both Mnuchin’s testimony and written responses.

    Volcker Rule 2.0: CREFC’s policy staff is inclined to believe, under a Mnuchin regime, that the Volcker Rule will be administratively softened in the years ahead. During testimony, Mnuchin said: “As Chair of FSOC I would plan to address the issue of the definition of the Volcker Rule to make sure that banks can provide the necessary liquidity for customer markets and address the issues in the Fed report.” Administrative reforms will probably mean a retool of the rule to more clearly define “prop trading” and facilitate greater liquidity as dealer inventories grow. This “bright line” referred to by Mnuchin could entail establishing metrics that would seek to delineate proprietary trading from market making.

    Stepping Back from the RNC’s Position on Glass-Steagall: During his testimony Mnuchin repeated his willingness to consider a reprisal of Glass-Steagall. While a “Glass-Steagall 2.0” has no apparent pathway to becoming law, as Congressional republicans have so far been adamantly against such a reform, we would caution the market that any future headline risk from the financial services industry could change opinions in Washington.. On the campaign trail, then-candidate Trump seemed warm to the idea of a “21st Century Glass-Steagall”, but the issue has not received much attention from his advisors since. Breaking up the banks à la Glass-Steagall appears to run counter in philosophy to relaxation of the Volcker rule.

    Like-Kind Exchanges and Tax Reform: In his written responses to questions from Committee Members, Mnuchin offered definitive, but targeted, support for certain like-kind exchanges: “I agree that farmers, ranchers, and small business should be able to use like-kind exchanges for real and personal property in order to operate efficiently, create jobs, and strengthen the US economy.” To be fair, the wording of his answer was mostly parroting the question’s language. Given this exchange and hearing from the chief tax writer in the House, we believe current odds favor little disruption of current like-kind exchange provisions (also referred to as 1031 exchanges) during the upcoming tax reform debate. Please see Tax section later in this bulletin.

    Fannie and Freddie. The Government-Sponsored Enterprises (GSEs) – Fannie Mae and Freddie Mac – were discussed as part of three separate Q&A segments, including both of Sen. Warner’s (D-VA) rounds. In aggregate, Mr. Mnuchin made three broad points. First, he distanced himself from calls to “recap and release” the GSEs and stated his hope for a bipartisan solution. Second, he described the GSEs as “very important entities” and touched on their role in ensuring secondary-market liquidity. Third, in the context of GSE reform efforts, Mr. Mnuchin repeatedly stated his goals were to protect taxpayers, ensure access to housing-related capital, and work in a bipartisan manner. Our view is that Mr. Mnuchin’s comments left just enough for everyone in the housing policy conversation to find something they can praise and something they can condemn, but we do not believe the broader mortgage finance policy conversation has been meaningfully altered. It is clear that Mr. Mnuchin is likely to bring a renewed sense of urgency to the issue, but other issues will be prioritized in the near-term (e.g., tax reform). Accordingly, our view remains that comprehensive mortgage finance reform legislation  meaning a bill that alters either the GSEs’charters or conservatorship -- only has ~30% likelihood of enactment in this Congress. We maintain, however, that the declining GSE capital buffers, the potential impact of tax reform on Fannie Mae’s and Freddie Mac’s deferred tax assets, and the upcoming change in personnel could compel targeted administrative policy shifts. Furthermore, Senator Crapo has kept GSE reform a priority.  So regardless of whether a bill can be passed this year, we believe that Senate Banking is highly likely to take up the debate this Congress.