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 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.
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 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 firstname.lastname@example.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.
On Tuesday, January 24th, the Senate Banking Committee overwhelmingly approved Dr. Ben Carson for the post of Housing Secretary, clearing him by voice vote. No date has been set for the full Senate to give Carson an up or down vote, but CREFC expects an easy path to confirmation barring any late-breaking developments.
While Mr. Carson’s testimony primarily concentrated on single-family housing, he did state, in line with President Trump, that “Overly burdensome housing regulations are bad for everyone and are increasing income inequality. Research by Harvard professors found that by reducing the ability of people to move around within an economy and between different economies, strict land use regulations are reversing 100 years of income convergence across U.S. states.” We believe this deregulatory theme will also apply to multifamily housing as well, though no details have been provided as such by Mr. Carson.
Forbes-Tate Partners is CREFC’s outside counsel for monitoring legislation outside of and intersecting with CRE, Congressional Leadership, and the White House.
As you know, comprehensive tax reform is at the top of the agenda for the Trump Administration and Congressional Republicans. Specifically, enacting comprehensive tax reform has long been a priority for House Speaker Paul Ryan; we fully expect him to expend significant political capital in order to get a bill passed out of the House of Representatives prior to the August recess. In preparation for a push to overhaul the tax code, House Republicans under Ways and Means Committee Chairman Kevin Brady (R-TX) last June released a blueprint that outlines their overarching vision for reform. This document was meant to provide a framework for House Republicans to run on during their re-election campaigns and to subsequently provide a path forward for the Trump Administration.
Currently, the Administration and Congress are working to add further details to the blueprint and to craft legislative language codifying the principles contained in the document. The timing for the release of a more concrete plan remains uncertain, but we expect to see a discussion draft or legislative language in the later 1st or early 2nd quarter. As expected, the process is fluid, with much of today’s corporate tax debate focused on new policies, including border adjustability (the so-called “BAT”), interest deductibility, and proportional expensing.
House Republicans are further along than their Senate counterparts, but we fully expect the Senate to turn its focus to tax reform following the completion of work on items including confirmation of Administration nominees, efforts to overturn Obama-era regulations through the Congressional Review Act, and legislation to repeal and replace the Affordable Care Act. We will continue to provide you with updates as the process progresses. Please see the next story to understand the implications for commercial real estate as it relates to tax reform.