Allan Meltzer

It is with sadness that Center for Financial Stability (CFS) mourns the passing of internationally renowned economist and Carnegie Mellon Professor Allan Meltzer.  Author of more than 10 books and 400 papers, he was one of the leading experts on the Federal Reserve.

Allan was a brilliant economist with contributions of historic importance.  He moved through life with the highest level of integrity and tenacity.  Allan was an economic intellectual with a remarkable ability to get along with economists having diverse views.  He and Karl Brunner were the founders of the Shadow Open Market Committee, which often disagreed with Federal Reserve policy.  Nevertheless, Allan was greatly liked at the Fed and was regularly invited to serve on the semiannual Panel of Academic Advisers, who met in the Board Room with the Governors.  The Federal Reserve’s initial decision to start providing monetary aggregates to the public long ago was based upon advocacy by Allan at the St. Louis Federal Reserve Bank.

Over decades, he influenced many CFS experts, colleagues, and friends.  Since the launch of CFS, Allan often took the time to voluntarily provide feedback or be involved in issues stretching from the Bretton Woods institutions, bank capital, Fed policy, to CFS Divisia monetary measures.  Allan was very familiar with the CFS Divisia monetary aggregates.  Soon after CFS Director William A. Barnett originated the Divisia money aggregates and presented his research in Tokyo, Allan served as a consultant to the Bank of Japan to produce and maintain Divisia monetary measures for Japan.

CFS thanks Allan for his meaningful and longstanding contributions.

OCC Publishes Revised Sections of Comptroller’s Licensing Manual

The Office of the Comptroller of the Currency (“OCC”) published revised versions of the “Public Notice and Comments” and “Fiduciary Powers” booklets of the Comptroller’s Licensing Manual.

The “Public Notice and Comments” booklet provides information about public notice requirements and procedures. The revised version replaces the booklet published in March 2007. The “Fiduciary Powers” booklet outlines policies and procedures for banks and federal savings associations exercising fiduciary powers. The revised version replaces the booklet published in June 2002.

Comptroller of the Currency Steps Down, Expresses OCC’s Continuing Commitment to Innovation

Comptroller of the Currency Thomas J. Curry announced that he will step down from his position on May 5, 2017. In a speech at the “Fintech and the Future of Finance Conference,” at the Kellogg School of Management, Northwestern University, Mr. Curry reaffirmed the continuing commitment of the Office of the Comptroller of the Currency (“OCC”) to facilitate innovation. He acknowledged the growing impact of FinTech companies, as well as the potential complications that accompany their continued progress and advancement.

In his remarks, Mr. Curry reviewed the OCC process that led to proposals for granting national bank charters to certain FinTech companies. In response to the rapidly expanding FinTech sector, Mr. Curry explained, the OCC launched a “responsible innovation initiative,” which was intended to ensure cooperation between regulators, traditional bankers, FinTech companies and other relevant entities. The initiative, which explored obstacles to innovation and considered regulatory support measures, eventually devised a solution of granting national bank charters to certain FinTech companies. To that end, the OCC published a draft supplement to the Comptroller’s Licensing Manual on March 15, 2017 that detailed the process of evaluating bank charter applications from FinTech companies. Mr. Curry addressed the opposition to these special purpose charters by advising restraint:

“At the heart of the issue is the fundamental nature of the business of banking – the business of banking is dynamic and I would urge caution to anyone who wants to define banking as a static state. Such a view risks choking off growth and innovation. The federal banking system has served as a common source of strength for communities across the country and for the broader national economy for more than 150 years because it was allowed to adapt to meet the evolving need of consumers, business, and communities.”

Mr. Curry also touted the OCC’s new Office of Innovation, and claimed that it will have an even greater impact on the industry than the FinTech charters, since it will serve to analyze all areas of financial innovation and eventually provide consistent, confidential regulatory advice. He emphasized that the Office of Innovation was put in place to support banks and FinTech companies, and to provide evolving guidance as new opportunities for collaboration and advancement arose.

Mr. Curry – who completed his five-year term as Comptroller on April 9, 2017 – will step down from his position on May 5, 2017. Keith A. Noreika will serve as Acting Comptroller.

House Passes Fair Access to Investment Research Act of 2017

The House of Representatives passed the Fair Access to Investment Research Act of 2017 (H.R. 910). The bill is intended to establish a safe harbor that would permit broker-dealers to issue research reports that cover exchange-traded funds (“ETFs”). The bill provides that research reports are not “prospectuses” (and so are not subject to Securities Act requirements that apply to prospectuses).

According to the Congressional Budget Office (“CBO”), the bill would eliminate an existing right of action that “allows public and private investors to pursue damage claims against broker-dealers who issue research reports on exchange-traded funds.” The CBO stated that it has not found any cases to date that established liability for information in research reports on ETFs, nor does it expect to find such cases in the future.

SIFMA issued a statement commending the passage of the bill because it would “reduce obstacles to research on [ETFs] and registered investment companies,” and because its clarifications would “allow broker-dealers to produce more research on ETFs, providing consumers with greater access to information and fueling capital formation and job creation.”

Currently, the bill is being reviewed by the Senate Committee on Banking, Housing and Urban Affairs.

Lofchie Comment: The reason that no claims are made against research on ETFs is that no one publishes such research. The reason no one publishes this research is because, under current law, the research might be deemed a prospectus. The reason this statutory amendment makes sense is that current law discourages the production of research that would be very useful to investors. It makes no sense to implicitly bar the production of research on one of the largest and most important investment tools in the market.

FDIC Publishes Handbook for Organizers of New Depository Institutions

The FDIC published a handbook for new depository institutions. The handbook was designed to help potential organizers become familiar with the deposit insurance application process and the path by which to obtain deposit insurance. The handbook offers, among other things, guidance on the three phases of establishing an insured institution: pre-filing activities, the application process and pre-opening activities.

Lofchie Comment: What is interesting about this publication is that it would seem to have no readership. There are virtually no new banks. See Federal Reserve Bank of Richmond, “Explaining the Decline in the Number of Banks since the Great Recession“; see also George Sutton, “What Dearth of New Banks Means for the Industry’s Future” (American Banker). Thus, the really significant question is not how does one start a new bank, but, rather, why does no one want to do so?

NY Fed Bank President Says It’s Time to Evaluate Post-Crisis Regulatory Regime, Questions Effectiveness of Volcker Rule

Federal Reserve Bank of New York (“NY Fed”) President and CEO William C. Dudley articulated several principles to consider when evaluating the post-financial crisis regulatory regime and raised questions about the effectiveness of the Volcker Rule.

Mr. Dudley stated that the financial crisis exposed flaws in the regulatory framework – in particular, capital and liquidity inadequacies at large financial institutions. He cited “a number of important structural weaknesses that made it vulnerable to stress” including: (i) systemically important firms operating without sufficient capital and liquidity buffers, (ii) risk monitoring, measuring and controlling failures, (iii) significant problems in funding and derivatives markets, and (iv) fundamental defects in the securitization markets. These weaknesses, he noted, were “magnified by the lack of a good resolution process for large, complex financial firms that got into trouble.”

Mr. Dudley argued that while the industry “must resolve to never allow a return to [pre-crisis] conditions,” now is an appropriate time to begin evaluating the changes that were made to the regulatory regime. He articulated three principles to keep in mind for an effective regulatory regime:

  1. “Ensure that all financial institutions that are systemically important have enough capital and liquidity so that their risk of failure is very low, regardless of the economic environment.”
  2. “Have an effective resolution regime that allows such firms to fail without threatening to take down the rest of the nation’s financial system, and without requiring taxpayer support.”
  3. Ensure that the financial system remains resilient to shocks by preserving “the centralized clearing of over-the-counter (OTC) derivatives, better supervision and oversight of key financial market utilities, and the reforms of the money market mutual fund industry and the tri-party repurchase funding (“repo”) system.”

Mr. Dudley suggested that regulatory and compliance burdens could be made “considerably lighter” on smaller and medium-sized banking institutions because “the failure of such a firm will not impose large costs or stress on the broader financial system.”

Mr. Dudley also questioned whether the implementation of the Volcker Rule was achieving its policy objectives. Regulating entities under the Volcker Rule is difficult, he argued, because most market-making activity has “an element of proprietary trading” and the division between market-making and proprietary trading is “not always clear-cut.” Mr. Dudley said that while the evidence may be inconclusive, the Volcker Rule could be responsible for a decline in market liquidity of corporate bonds. Mr. Dudley strongly recommended Volcker exemptions for community banks.

Lofchie Comment: Mr. Dudley notes that the profitability of banks has dropped in light of their reduced leverage, but he asserts that they remain “profitable enough to cover their cost of capital.” What makes this remark particularly notable is the contrasting recent assertion of FDIC Vice-Chair Thomas Hoenig who claimed that (i) banks’ return on equity was low because they were too highly leveraged (a completely counterintuitive assertion that Mr. Hoenig did not fully explain) and (ii) that banks were less profitable than essentially every other industry (which would seem to suggest that banks were not profitable enough to cover their costs of capital, or at least that investors’ capital was better deployed elsewhere). Whatever is causing the decline in bank profitability (leverage too high or leverage too low), bank regulators should worry that the firms that they regulate are not making enough money to sustain themselves for the long term.

Sargen on Corporate Tax Cuts versus Tax Reform Revisited


  • As part of “the largest tax cut in history” the Trump Administration is proposing to lower the corporate tax rate to 15% while shifting to a territorial system in which U.S. companies no longer would be disadvantaged on taxation of overseas profits.  The stated goal is to boost long-term economic growth through increased business capital spending.
  • The one page proposal, however, is really a wish list of tax cuts for corporations and individuals, rather than a plan to reform the tax code.  That is the goal of the bill Paul Ryan and House Republicans drafted last summer; however, prospects for its passage have been hurt by failure to repeal Obamacare.
  • While equity investors are banking on corporate tax cuts to be enacted later this year, the unanswered question is how they will be paid. The President and his supporters contend the proposal pays for itself with stronger growth.  However, the risk is the federal deficit will blow out from already high levels.

The Trump Administration’s Wish List

Throughout the 2016 campaign, Donald Trump advocated lower taxes for businesses and individuals as a way to bolster economic growth, and he called for the corporate tax rate to be lowered to 15% from the current rate of 35%.  Because there were few details to back this proposal, however, investors focused on the tax bill drafted by Speaker Ryan and the Republican House leadership, as it had broad support among the Republican rank and file.  It contained four key provisions: (i) reduce the corporate tax rate to 20%; (ii) allow immediate expensing of capital outlays, but exclude interest deductions; (iii) incent businesses to repatriate profits earned abroad; and (iv) implement a border-adjustment-tax (BAT) that would effectively subsidize exports and tax imports.

The intent of the Republican bill was to streamline the tax code and facilitate passage by making it deficit neutral.  With the first three provisions generally consistent with the President’s agenda, market participants focused on the BAT provision that is controversial because of the adverse consequences for firms that rely on imports.

In the wake of the health care fiasco, the prospects for a tax bill that is deficit neutral were dealt two major blows: (1) The failure to replace Obamacare meant the Republican leadership could not garner the projected savings in revenues of more than one trillion dollars over ten years that would have occurred if Medicaid expansion had been halted.  (2) The wrangling over health care made it less likely that the BAT provision would clear the tax bill, because it is too complex and too controversial.

As these developments unfolded, I envisioned a situation in which Speaker Ryan would tell the President that he could no longer support a 20% corporate tax rate unless additional revenues were forthcoming.  Instead, the President upped the ante on Speaker Ryan and the Republican leaders in Congress this past week by stating he favored a 15% corporate tax rate and that he was not concerned about the budgetary consequences. (According to the Urban-Brookings Tax Center, lowering the corporate tax rate to 15% could entail a revenue loss of $2.4 trillion over 10 years, or $600 billion more with a 20% tax rate.)  In addition, the Administration’s proposal appears to drop the BAT provision, which is estimated to generate more than $1 trillion in revenues over the next ten years, and is silent on the issue of deductibility of interest expense.

In the Trump Administration’s view, a lower tax rate would spur stronger economic growth, which would boost tax revenues.  The problem, however, is that tax cuts may provide a boost to the economy by increasing aggregate demand, but the effects are likely to be only temporary if they blow out the budget.

Do Budget Deficits Matter?

This issue loomed large during the 1980s when the Reagan Administration achieved significant tax cuts for businesses and individuals that helped boost the economy.  Although they were accompanied by a significant expansion in the budget deficit, interest rates plummeted from record levels, mainly because the Federal Reserve succeeded in reining in inflation and inflation expectations.  Accordingly, many people at the time concluded budget deficits did not matter for the economy or financial markets.

One needs to be careful about drawing this inference today, however, because the economic environment is very different.  First, inflation and interest rates are near record low levels, and they are likely headed higher as the economy improves and the Fed normalizes interest rates.  Second, the trend rate of economic growth has fallen from more than 3% per annum to about 2% p.a. in the past decade. The challenge the Administration and Congress face is that it is not easy to boost productivity growth and increase labor force participation.

According to the Congressional Budget Office (CBO) projections based on recent trend growth, the budgetary picture is about to worsen in the absence of any policy changes: The federal deficit is projected to grow from less than 3% of GDP to more than 5% by 2027.  This is mainly due to increased outlays for entitlement programs such as Social Security, Medicare and Medicaid owing to the aging of the population and medical costs that have outstripped the pace of inflation.  Stated another way, ten years from now all federal revenues would go to pay for entitlements and debt servicing costs, meaning that all discretionary programs would have to be covered out of deficit financing.

Supporters of lower tax rates counter the picture is far less bleak if trend growth of 3% is restored. (See the commentary by Stephen Moore “Growth Can Solve the Debt Problem” in the Wall Street Journal dated April 26.)  This line of reasoning, however, is risky, because one can always assume the problem away via optimistic growth rate assumptions.  (See the commentary by former CBO Director, Douglas Holtz-Eakin, “Trump’s Tax Plan is Built on a Fairy Tale” in the Washington Post dated April 26.)

So far, at least, financial markets have adopted a “wait and see” posture.  Equity investors are banking on a boost to the economy and corporate profits from tax cuts being enacted, while the bond market is dubious, but supported by lower interest rates abroad.

Speaker Ryan and Republican leaders in Congress, however, are more concerned about prospects for the budget. They are likely to push back on the President’s tax initiatives, especially when he is also supporting increased spending on defense and infrastructure and no checks on the growth of entitlement programs.  It remains to be seen, therefore, how the political process will play out, and whether the President’s tax proposal or the Congressional Republicans’ will prevail. Meanwhile the process is expected to drag on for a long time and possibly into next year.

NASAA Warns Financial CHOICE Act Moves in “Wrong Direction”

In testimony submitted to the House Financial Services Committee (“Committee”), North American Securities Administrators Association (“NASAA”) President Mike Rothman argued that the updated Financial CHOICE Act should not be passed in its current form. Mr. Rothman objected to bill provisions related to enforcement and regulatory authority, capital formation, and investor protection.

At a hearing before the Committee, Chair Jeb Hensarling (R-TX) introduced the Financial CHOICE Act of 2017. As previously discussed, this bill is an update of the CHOICE Act of 2016 (see the Committee’s summary of changes) and represents a major overhaul of the current financial services regulatory regime including a partial repeal of Dodd-Frank.

Mr. Rothman testified that the proposed Financial CHOICE Act of 2017 would weaken important reforms and protections, undermine regulators’ ability to enforce financial laws, and “dramatically change regulatory policies in the wrong direction.” He argued that state securities regulators are concerned the bill would unnecessarily expose investors and markets to significant new risks, and replace efficient protections with ineffective measures:

“By attempting to eviscerate so many critically important reforms – weakened oversight of private securities markets and reforms; watered down provisions intended to expand fiduciary obligations to investment professionals; lowered standards for securities sold to the investing public; diluted rules that keep “bad actors” out of our securities markets, among many others – the legislation blithely aims to sweep away in one stroke scores of essential protections and modernizations to our financial regulatory architecture. . . .”

Specifically, Mr. Rothman noted objection to Section 391 of the proposed legislation. He argued that NASAA objects to a mandate governing the coordination of state and federal enforcement actions because it would hamper the voluntary state-federal collaborative framework that is in place already.

Lofchie Comment: CHOICE Act Section 391 requires that various federal agencies (which are enumerated in Section 311 of the bill, but essentially includes the major U.S. financial regulators) better coordinate among themselves which agency should be the lead in any regulatory action where numerous agencies are involved. It does not, by its terms, impose any obligations on state regulators; it merely requires that the federal government act as a unified entity (which would seem entirely sensible, would conserve the government’s resources, and would reduce the nightmare scenario of a business dealing with multiple regulators in regard to any one single issue). The Section does not require the states to coordinate either among themselves or with the federal government, although it would be good if they were to do so.