There is always more than one reason for a bank failing. It starts with poor management. Matters get worse if the bank’s directors and regulators fail to heed warning signs of deteriorating conditions. SVB appears to be such a case. In walking through this failure, I am relying on public data and, therefore, I acknowledge I may not have all the facts.

First, it goes without saying that the principle fault lies with management and the board. There is no need to explain this further.

Second, the Federal Reserve’s (FED) and its monetary policy contributed to the problem. Its policies of printing enormous amounts of money and holding interest rates close to zero for over a decade, created the expectation that such a policy would last forever. The Fed said it would keep interest low for a “considerable period”. Bank management believed this promise and expanded its use of highly concentrated uninsured deposits. It then invested a good part of this money in billions of dollars of long term government guaranteed securities, assuming their value would remain steady in a environment of perpetually low interest rates. Management foolishly failed to allow for a reversal of that policy even as it was taking place.

Third, bank supervisors failed to heed the red flags showing that the bank was funding its growth with high concentrations of uninsured deposits. The bank grew by over 60% per year for three years. Such growth should have been examined and dealt with early on in the bank’s expansion. If this had been done, its regulator would have observed the concentration of deposits and could have taken action to require a more stable funding source which would have also slowed its growth.

Fourth, the regulator apparently relied on the bank’s risk-weighted capital standard for judging SVB’s balance sheet strength. Under the risk weighted system government and government guaranteed securities are not counted as part of the balance sheet for calculating capital to “risk-weighted” assets. This allowed the bank to report a ratio of around 16%, giving the appearance of strongly capitalized bank. However, this calculation failed to account for interest rate risk in its securities portfolio or the risk of having a highly concentrated balance sheet. It misled the public, and apparently the regulators.

In contrast, if the regulator had focused on SVB’s ratio of equity capital-to-total assets, including government securities, the ratio falls to near 8 percent; and if the had calculated the ratio as tangible capital-to-assets (removing intangibles and certain unbooked loses from capital) the ratio would have fallen to near 5%. What this would have disclosed to the world is that the bank’s assets could not lose 16% of of their value before insolvency but only 5%, a stark contrast.

Had the regulator not relied on the misleading risk-weighted capital measure, it might have take actions sooner. A simple capital-to-asset ratio, tells the regulator and public in simple, realistic terms how much a money a bank can lose before becoming insolvent. The regulatory authorities need to stop pretending that their complex and confusing capital models work; they don’t.

Also, regulators know that rapidly growing banks are inherently more risky and require more capital to absorb the lending and investing mistakes that come with exceptionally fast growth. In this instance the regulator should have insisted that such growth be funded with substantially more capital to allow for the risk.

Whether SVB would have failed if these errors had been address earlier and vigorously, we cannot say for certain. However, failing to address them assured its failure.

SVB: The Blame Game Begins was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

Squawk on the Street on Twitter: "Will the FDIC's decision to backstop $SIVB depositors weaken market discipline moving forward? @tom_hoenig thinks so, saying the agency has set the expectation that it will assist other regional banks suffering similar distress moving forward. pic.twitter.com/1McCdyy51T / Twitter"

Will the FDIC's decision to backstop $SIVB depositors weaken market discipline moving forward? @tom_hoenig thinks so, saying the agency has set the expectation that it will assist other regional banks suffering similar distress moving forward. pic.twitter.com/1McCdyy51T

Tom Hoenig discusses SVB on CNBC was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

1. Federal Reserve purchasing trillions of dollars of government debt and paying for it with nearly $9 trillion in newly created liabilities that ballooned bank liquidity.
2. Federal Reserve holding interest rates near zero, with statements that it would keep them at that level indefinitely, and encouraging banks and business to engage in speculative activities to boost the economy.
3. SVB accepting a high concentration of uninsured deposits from venture and equity funds while the regulatory authorities watched.
4. SVB choosing to grow its assets by an average of 67% per year for three years; purchasing credit-risk-free, longer term, low yielding government or government guranteed securities, while accepting significant duration risk by assuming the Federal Reserve would keep interest rates low. This led to reported unrealized losses in the securities portfolio that essentially wiped out its available capital.
5. Regulators allowing SVB to systematically increase its risk profile, judging it as adequately capitalized with a risk-rated Tier I capital ratio of 16%, when the capital-to-assets ratio was less than 8%, and the tangible capital-to-asset ratio was near 5%. In contrast, requiring SVB to fund itself and maintain a capital-to-asset ratio closer to 15%, likely would have slowed its 67% average annual growth rate and reduced its probability of failure.

As the Federal Reserve continues to fight inflation and raise interest rates, SVB should be a wakeup call to the industry and its regulators to plan for more of these kinds of events. The banking industry has well over $600 billion of unrealized losses hanging over it and as rates continue to rise, the value of other assets will come under downward pressure. SVB is a warning to each of these groups that the fight against inflation will be costly, and how to handle future losses and volatility should be priority number one.

SVB: So Many Reasons To Fail was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

We will be moving to Substack starting next week. You can go to Finregrag.substack.com now if you want to sign up. (We are in the process of migrating content, so it may be a little incomplete.) Starting next week finregrag.com will direct to the new Substack site.

See you there!

FinRegRag on Substack, coming soon! was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

The Supreme Court has accepted the CFPB’s petition to review the Fifth Circuit’s decision that its funding structure is unconstitutional and therefore its payday rule is invalid. Congress funded the CFPB by allowing it to set its own budget and receive money from the Fed. The CFPB is therefore insulated from the normal congressional appropriations process. The Court will decide whether this method of funding is consistent with the Constitution.

That constitutional issue is difficult, but even more delicate is the question of a remedy if the Court does hold the funding method unconstitutional. What relief does the Court grant the plaintiff? Is just the payday loan rule invalid, or should the Court conclude that the CFPB never had a legitimate source of money for operations? Some people are nervous that if the Court does find the CFPB’s funding structure unconstitutional that everything the CFPB has done is invalid and the large parts of the market that the CFPB regulates will be thrown into chaos. For example, the Mortgage Bankers Association has expressed concern that if the CFPB’s funding structure is struck down it will be unable to administer the rules that govern the mortgage market, grinding the market to a halt.

But is there a way for the Court to strike down the CFPB’s funding without risking a market apocalypse? Very possibly, and the Court has demonstrated the mechanism in another recent and important separations of powers case, Collins v. Yellen. In Collins shareholders of Fannie Mae and Freddie Mac (collectively the GSEs) sued to try to stop the Federal Housing Finance Agency (FHFA), acting as the GSEs’ conservator, from denying the shareholders sizable financial benefits from the GSEs. One of the arguments of the shareholders was that the relevant statutes improperly restricted the President’s power to remove the head of the FHFA. The Court agreed and found the removal restrictions unconstitutional. Great, the plaintiffs win, and the FHFA has to write a big check, right?

No. Instead, the Court remanded the case back to the Fifth Circuit with orders that the lower court analyze whether the unconstitutional removal provision was a cause of the financial injury the shareholders claimed. The Court distinguished this case, where the Director acted pursuant to valid statutory authority, from a line of cases where government officials used authority they did not properly have. In Collins the Court held that a constitutional defect does not automatically entitle a plaintiff to retrospective relief, though as Prof. Nielson points out, it may give rise to prospective relief. Instead, the constitutional defect needs to be a cause of the harm, and the plaintiff has the burden of proof. (How much of a cause the defect needs to be is unclear.)

This might strike you as unsatisfying. It certainly was for Justice Gorsuch whose partial concurrence lamented the lack of meaningful relief the decision would provide. However, as Justice Kagan pointed out in her partial concurrence, this sort of remedy does mitigate the risk that a body of regulation that the economy has come to rely on will be uprooted suddenly.

What might this mean for the CFPB’s funding? While it is certainly possible that the Court views Appropriations Clause questions as fundamentally different from a question about the President’s power to remove an officer, the Court could rule that the CFPB’s funding structure is unconstitutional and that going forward Congress must appropriate funds.

But what about the plaintiffs? To prevail in their effort to get the payday rule struck down, they would presumably need to show that the current funding method was a cause of the problems with the rule and that, if the CFPB was on appropriations, it would not have been able to put the rule forward.

This is a hard case to make, especially given the Fifth Circuit’s determination that the CFPB’s rule was consistent with statutory authority and procedural requirements. The plaintiffs would need to point to credible evidence that Congress, if it had control over the CFPB’s funding, would have prevented the CFPB from doing the rule or at least its objectionable aspects. To be sure, there is a lot of rhetoric on both sides that putting the CFPB on appropriations would result in its defunding, but the reality is that meaningful defunding of agencies is extremely rare if not unheard of.

In Collins and Seila Law, where the Court invalidated restrictions on the President’s power to remove the CFPB Director, the Court was hesitant to assume the President or Congress would take dramatic steps if it was forced to proceed without a discreet unconstitutional provision. Having passed a law creating and empowering the CFPB the Court might reasonably assume that it would be provided at least some funding. Such an assumption would of course be rebuttable, but the Court would likely remand the case on that very question.

The practical upshot would be that all of the CFPB rules would probably not go away in a flash and that CFPB enforcement actions wouldn’t all be voided instantly. Instead, in the future, the CFPB would need to rely on Congressional appropriations, which is a major form of congressional oversight of agencies. The other practical upshot is that this process could be repeated for other agencies that operate outside of appropriations like the OCC, FDIC, and, yes, the Federal Reserve.

Of course, those agencies are different from the CFPB, and the Court could distinguish them for constitutional purposes. But even if they are not different, the Court wouldn’t need to strike everything down. The possibility for the Court to hold an element of an agency’s structure unconstitutional while remanding for possible retrospective relief doesn’t require the Court to make sudden or sweeping substantive changes to law and regulation to impose significant corrections to the structural safeguards of the administrative state.

How the Court might put the CFPB on Appropriations Without Blowing Up the Economy was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

Research

• Regulation, CDO Exposures, and Debt Guarantees through the Financial Crisis. Working Paper by Stephen Matteo Miller.
• Artificial Intelligence: An Introduction for Policymakers. Primer by Matthew Mittelsteadt.

Public Comments and Testimony

• Principles for Climate-Related Financial Risk Management for Large Financial Institutions. Public comment by Stephen Matteo Miller and Raymond Kim.
• Revamping and Revitalizing Banking in the 21st Century. Written testimony by Brian Knight for a hearing on February 8 held by the House Subcommittee on Financial Institutions and Monetary Policy.

Commentary

• Federal Reserve is ‘talking tough, but words are not enough’. Thomas Hoenig on Fox Business Network’s “Mornings with Maria.”

FinRegRag

• The Economic Outlook: Four Questions to Consider by Thomas Hoenig.

February FinReg Roundup was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

Introduction

Economic forecasting is a hazardous undertaking. Consider, for example, that the Federal Open Market Committee (Fed) forecasted just over a year ago, that the appropriate Federal Funds Rate would be less than 1 percent at the end of 2022. When the Fed made that rate forecast, it claimed inflation was due to temporary supply disruptions that would self-correct. It gave far less weight to the significant increase in aggregate demand that it had helped create. In June of last year CPI inflation reached a forty year high of 9 percent; however, having raised rates aggressively since then, the Fed is forecasting that inflation will return to its 2 percent target next year, and that while the economy will slow, there will be no recession. This is an attractive forecast, but is it really the most likely?

In what follows, I will frame a somewhat different economic outlook around four questions:

1. What caused CPI inflation to rise to an historic 9 percent annual rate in June of 2022?
2. Will the Fed reestablish price stability as defined by its 2 percent inflation target?
3. Will the Fed trigger a recession?
4. What policy risks lie ahead?

Question 1: What caused CPI inflation to rise to an historic 9 percent?

This question has been discussed extensively, but it is fundamental to addressing the outlook. The pandemic was the trigger to a tragic economic upheaval. However, the pandemic was only one factor contributing to inflation.

The pandemic reduced economic output — aggregate supply. It put people out of work, it disrupted global supply and multiplied the emerging effects of global trade frictions. These market disruptions and accompanying recession were brutal for the American public.

Rather than allow this to continue unabated, the government and Fed, initiated the most expansionary spending and money creation processes witnessed in the U.S. outside of a wartime environment; and it did so for a period well beyond the pandemic crisis. The government increased its spending from $4.4 trillion in 2019 to above $6.5 trillion, a 50 percent increase, in each year 2020 through 2022. Today with the recently passed omnibus bill, government spending will again exceed the $6 trillion dollar mark.

During the 2020 through 2021 most of the additional spending went directly to businesses and consumers. The Fed estimates government programs not only sustained private spending but led to an excess of personal savings (the amount above historic averages) by $2.5 trillion. Also, the money for this spending was nearly all borrowed as the government did not increase taxes, and its debt expanded from $22.5 trillion in 2019 to over $31 trillion now.

If the government borrows to spend, it historically does so from the private sector or other external sources, which reduces private demand. However, increasingly the government borrows from the Fed, which literally creates the dollars to purchase debt. For example, the Fed’s balance sheet increased from less than $4 trillion in 2019 to nearly $9 trillion today (up from $900 billion in 2007). The Fed also kept interest rates near zero, further stimulating demand through greater business leverage. As a result, money growth in the U.S. between 2019 and March of 2022, increased at an annual rate of more than 20 percent.

These policies helped increase aggregate demand above that destroyed during the pandemic. There was little chance that the recovery of supply channels and increases in productivity could satisfy this excess demand. In its simplest form, there was too much money chasing too few goods and services. Without timely actions on the part of the government and the Fed, inflation was inevitable; and there was no timely action.

U.S. CPI inflation increased from less than 2 percent prior to the pandemic to above 9 percent in June of 2022, and as just reported for December it was still 6.1 percent higher than a year ago. Real estate also experienced serious inflation where, for example, shelter inflation rose from 4 percent in January 2022 to 7.5 percent by year end.

Question II: Will the Fed Reestablish Price Stability?

The Fed can reestablish price stability, defined as a 2 percent annual inflation rate, but it won’t be easy or quick. The Fed is using two tools to do this. First, it is increasing interest rates; second, and less discussed, it is shrinking its balance sheet at a rate of $95 billion per month.

The Fed has increased its policy rate, the fed funds rate, from near zero a year ago, to near 4.25 percent currently, and it will likely be 5 percent or higher in the first half of this year. As intended, the U.S. economy is slowing. Interest sensitive sectors experienced its effects early. U.S. residential real estate prices have declined 10 consecutive months. Housing starts fell from a high of over 1.8 million units in April to 1.4 million units during December of last year. Also, commercial real estate is slowing as it confronts higher interest rates, soaring prices of materials, and accelerating wage costs. Other growth industries, tech for example, are also suffering as rates have an inevitable slowing effect on income growth and cash flow.

The second force slowing the economy is the Fed’s action to reduce the size of its balance sheet. As it does this, it reduces bank reserves and, therefore, market liquidity and bank lending, which adds to the effects of rising rates. While the reduction in reserves may seem moderate given the overall level, it is a reduction in reserves of above a trillion dollars annually.

These actions are having the intended effect. As of this past December, the CPI year-over-year inflation rate declined from 9 percent in June to 6.1 percent in December.

However, the Fed isn’t ready to declare victory. It keeps reminding the world that labor demand remains exceptionally strong and wage demands are putting upward pressure on prices. Also, the inflation experienced over the past year has found its way into core measures of inflation, which removes food and energy, and has fallen less rapidly than overall inflation.

Also muddying the water is the federal government’s spending and borrowing. Its spending remains above $6 trillion, adding to aggregate demand. It is also projecting annual deficits of over a trillion dollar well into the future. This spending and borrowing put the burden of solving inflation more directly on the Fed rather than Congress. It also makes the Fed the villain, should the economy fall into recession.

The Fed understands its predicament and the pressure that will build for it to fund future deficits at lower rates. But it insists that it will raise rates until it is certain that excess demand is brought into balance with the economy’s growth potential and that inflation is checked. Jay Powell, the Chairman of the Fed, says he is taking a Volcker-like approach in addressing this inflation. For those who know the effects on the economy of Volcker’s policy, Powell is saying the Fed will risk a serious recession rather than see inflation reignite in 2023 and beyond.

Question III: Will the Fed Trigger a Recession?

While the Fed suggests it will accept a recession, it is not projecting a recession. It is projecting an economic slowdown in which GDP growth falls to a .5 percent annual rate in 2023, strengthening further in 2024 and 2025. This is a plausible outcome. Unemployment, for example, remains low at 3.5 percent despite the economic slowdown. Ten million jobs are available to those qualified and only 6 million job seekers. As the economy slows, jobs losses may show up to some extent in fewer posted job openings and less in unemployed individuals. If so, the unemployment rate may not increase much above 5 percent. Thus, the shortage in available labor may provide the needed cushion for the labor market.

The economy is also benefiting from an expanding energy industry and lower energy prices. There also appears to be a shortage of housing, ready to recover when rates settle to a lower, stable rate. Lastly, as the pandemic recedes and demand recovers, consumers should return to in-store buying, which would improve the outlook for retail space.

These serendipitous economic conditions, however, are being offset by other events that may require the Fed to push rates higher for longer. Average hourly earnings were up 4.6 percent in December over the previous year. While this is down from a year ago, labor is still suffering a loss of real income and is feeling the pinch. The rail industry, airlines and some major manufacturers recently have been reminded that labor wants a greater share of the income pie. For labor to accept slower wage increases forward, it must be convinced that stable prices have returned, and that may take a recession and higher unemployment.

For these reasons, the Fed appears insistent on raising rates from 4.25 percent to 5 percent or higher over the next half year. It has allowed the yield curve to become and remain inverted, which signals a recession ahead. With its declining balance sheet and reserves, deposits and loanable funds are less abundant (liquidity constrained). Such policies, if they continue, cannot help but make the banking industry more vulnerable, more cautions in its lending and, therefore, lead to slower growth.

Also, the consumer is spending its excess savings, consumer debt has increased, both of which suggest reduced spending ahead. Finally, trade frictions are not receding, and the rest of the world’s economies are slowing and less a source of growth for the U.S. A global conflict remains a concern. All these factors add to economic uncertainty and impinge on economic growth.

Sorting through these differing trends, it seems more likely than not that the U.S. will experience a recession in 2023. While the Fed is projecting .5 percent growth in 2023, it is adamant that its priority is 2 percent inflation, suggesting it will accept a recession. How bad might the recession be is unknown. It depends importantly on government and Fed policy choices that have yet to be made.

Question 4: What policy risks lie ahead?

Should a recession take hold, business bankruptcies and bank loan losses will increase, and unemployment will rise to 5 percent or higher, and CPI inflation will decline more quickly toward the 2 percent target. Also, and importantly, the Fed will be anxious to reverse its stance. As inflation and wage increases decline in late 2023 or early 2024, the Fed will begin discussions about when to lower its fed funds rate from its peak rate toward what might be considered a longer-term equilibrium Fed funds rate, perhaps 2 to 2.5 percent. The discussions will include the level but also how quickly rate changes should come, and this presents at least two notable risks to future policy decisions.

The first risk concerns how the Fed will react to the political and public pressure that comes with the recession. The Fed says repeatedly that it is committed to its policy. However, as the economy slows and unemployment increases, politicians, Wall Street, and the public will press the Fed relentlessly to ease policy, even if inflation slows only modestly. This risk will be more acute the more GDP falls and unemployment rises. This was the pattern in the 1970s, which led to the repeated episodes of inflation then recession until inflation reached nearly 14 percent, and the Fed was compelled to raise rates to 20 percent. This action finally broke the inflation cycle but at a terrible price in lost growth, unemployment, and lower income across the economy.

This is no small risk. Over the past 2 ½ decades the Fed as moved beyond just managing interest rates. It has added a new tool to its policy kit. If, for whatever reason, the economy slows, falls into a recession, or experiences a financial crisis, the Fed not only lowers interest rates, but injects substantial excess liquidity into the system to stabilize markets. Examples of such actions include the late 90s in response to the Asian and Russian financial crisis, the dotcom bubble and 9/11 shock. It took the policy to a new level following the Great Recession — calling it quantitative easing, or QE. It relied on QE during the repo liquidity shock of 2019, and most recently the pandemic. As a result, its balance sheet has increased from less than a trillion dollars as late as 2008 to 9 trillion dollars at the end of 2022. QE and interest rates both are now the principal tools of monetary policy, used lavishly when trouble threatens, and Wall Street and Congress have come to expect this from the Fed.

The second risk is that the Fed is aware of the market’s skepticism of its resolve. To regain credibility, it has messaged that it will accept a recession to assure the return to 2 percent inflation. Unfortunately, it cannot know for certain what policy calibration will achieve its goal. In its zeal to remain firm, it may raise rates too high or keep rates elevated too long, worsening consumer confidence, as it slows the economy. Inflation may decline more quickly toward 2 percent but at a cost of slower growth, loss of jobs and income. At that point the Fed would find itself struggling to regain control of its policy and the economy.

Complicating these risks are a host of external factors that will affect the U.S. and global economy making the policy choice increasingly risk prone. The Federal debt continues to grow, and the Fed will be pressured to provide the liquidity to fund it. Trade friction remains an issue and other supply bottlenecks make judging the source of inflation difficult. The Fed must manage policy around these risks and find a path back toward 2 percent with minimal damage to the U.S. economy.

It will be a difficult task for the Fed to work through these challenges and risks. It might succeed but it will be a very bumpy policy ride.

Summary

Boiling this outlook down to its essence: the Fed knows it must slow the economy to bring inflation to 2 percent, and it is doing so. It expects it will be successful and avoid a recession. However, it is just as likely that the economy will suffer a recession and if so, it is better to suffer a moderate one now than a more severe one later with all its more costly effects. The Fed’s goal is to calibrate the funds rate lower, perhaps 2.5 to 3.0 percent, a level it may conclude is consistent with low inflation, low unemployment, and stable long run growth Finally, the Fed must balance its policy between being too timid and too aggressive. Its track record is sketchy. Maybe this time will be different.

The Economic Outlook: Four Questions to Consider was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

Commentary

• The new Congress can ensure better, clearer financial regulation. Here’s how. Brian Knight in The Hill.
• Basic R&D in digital assets could lead to breakthroughs in innovation, competition. Agnes Gambill West in The Hill.
• Ohio’s ‘Regulatory Sandbox’ Deserves Cheers, But More Must Be Done. Logan Kolas and Agnes Gambill West in RealClearPolicy.
• American banks need to repair their capital buffers. Thomas Hoenig in the Financial Times.
• FTX Probe Does Not Justify US Law Enforcement Imperialism. Andrew Vollmer in Law360.
• Thomas Hoenig discusses the debt ceiling debate on Episode 512 of Newt’s World.

Testimony and Public Comments

• Testimony on Workforce Management Disclosures and Other SEC Issues. Written testimony by Andrew Vollmer for House Financial Services Subcommittee on Investor Protection, Entrepreneurship, and Capital Markets hearing, “E, S, G and W: Examining Private Sector Disclosure of Workforce Management, Investment, and Diversity Data.”
• A Universal Sandbox in Missouri Can Promote Innovation and Regulatory Reform. Written testimony by Agnes Gambill West submitted to the Missouri House Committee on Economic Development in relation to House Bill 268.
• ANPR Resolution-Related Resource Requirements for Large Banking Organizations. Public comment by Stephen Matteo Miller and Thomas Hoenig in response to the ANPR on TLAC for category II & III “regional” banks.

FinRegRag

• Wells Fargo, Firearms, and Florida (TL;DR edition) by Brian Knight.

January FinReg Roundup was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

Update (2–22–2023): I spoke with someone from Wells Fargo who provided this statement:

Wells Fargo does not have a policy against doing business with firearms companies, and provides financial services to firearms businesses. Based on our analysis of the risk associated with this customer, we made a decision to close the accounts. Our decision is not based on the industry.

There is now a material dispute about what drove the bank’s decision. Which side is right is unlikely to be known concretely absent some sort of investigation or law suit. If there are further developments I will update.

Stephen Gutowski reported today in the Reload that Wells Fargo has closed the personal and business accounts of a Florida gun store owner, citing risk management, as well as a line of credit, citing guidelines excluding lending to certain businesses. There are of course concerns that this reflects a broader exclusion of lawful but disfavored businesses, potentially due to private or public political pressure and a desire to de facto regulate. This topic is one I spend a lot of time thinking about, and began writing an analysis of what this might mean, whether Florida intervening, either in this case or future cases might be justified, and what a response might look like. 4500 words later I realized I wasn’t going to be able to put it up as one blog post but would need to break it up. While I am working on that (which my be delayed due to travel) here is a quick reaction. I withhold the right to change my mind, more facts might develop, etc. etc. I will update and link to the longer piece(s) as appropriate.

First, let me acknowledge that there isn’t much in the way of detail reported. The bank didn’t elaborate when asked and we only have the customer’s statement to go by. As such, it is possible that facts will develop that fundamentally change the analysis. (See update above.) That said, I am going to assume that the customer is both law abiding and a good credit risk. Why? Because if not the bank is more likely to have non-controversial reasons for cutting ties and would presumably be able to articulate those reasons to the customer. It also allows to this to serve as a hypothetical template for future questions of how states should respond to politicized finance.

With that said, the question of whether Florida, whose governor is explicitly hostile to “woke” capitalism and has strong Republican majorities on both houses of its legislature and therefore could pass legislation, should respond to this type of issue is an important one. To analyze this, I think the most relevant questions are:

1. What is motivating the banks decision? Is it pure economics where the bank feels it could use its resources more effectively with other customers? Is the bank being used or pressured by some private constituency, such as its management, employees, or other customers, as a tool to cut off legal but disfavored industries as a tool to curtail those industries? Is the bank responding to pressure from regulators?

2. What legitimate interest would Florida be seeking to vindicate by intervening in this or future decisions? Is Florida trying to protect the ability of its citizens to exercise an explicit constitutional right? A more general value of political equality or not being de facto regulated by the wealthy and powerful? Would Florida be trying to hold banks to their obligations given the “Regime of Privilege” they enjoy thanks to public policy? Are they trying to protect Florida investors in banks who may not be engaging in profitable business with disfavored companies? Or are they trying to protect Florida industry and the jobs and taxes that come with them? How much should we care about intent versus practical effect?

3. If intervention is justified, what form should it take? Would Florida follow Georgia and Wyoming by prohibiting banks using being a firearms business as a criteria for extending services or would they follow Texas and exclude banks who refused to do business with firearms businesses from doing business with the state. Is there another option?

To lay my cards on the table — I do think there are scenarios where state intervention could be justified. Especially if the bank’s actions are intended to frustrate people engaging in lawful and constitutionally protected activity. This could be the result of the bank management’s desire or that of another constituency, but regardless, the more the desire to use banking as a tool of de facto regulation is in play, the more suspect the bank’s actions are.

Likewise, the more the state is motivated by protecting its citizens from said de facto regulation the more likely I think it is to be legitimate. Conversely, the more the state’s actions are driven by protecting Florida businesses from true market forces, the less likely intervention will be justifiable.

Finally, all else equal I think the anti-discrimination path is the preferable one. This is because it enjoys a moral clarity, a simplicity of enforcement, and poses less risk that taxpayers will be disadvantaged by reducing options for things like placing municipal debt. That said, strong argument can potentially be made both for non-intervention and for the exclusion path.

This is just a quick reaction, and clearly doesn’t cover all the potential issues or nuances. As I go through the longer piece, I will update this with links and revisions as appropriate.

UPDATE: Wells Fargo disputes that decision was industry driven — Wells Fargo, Firearms, and Florida… was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.

Commentary

• FTX crash illustrates Congress’s weakness on tech. Here’s a solution. Matthew Mittelsteadt in The Hill.
• The unchecked power of federal bank regulators. Thomas Hoenig and Brian Knight in The Hill.
• The CFPB cannot be made immune to the Constitution. Brian Knight in American Banker.
• Thomas Hoenig discusses Fed minutes on CNBC’s “Closing Bell.”

Research

• Administrative Browbeating and Insurance Markets. Mercatus working paper by George A. Mocsary, Professor of Law, University of Wyoming College of Law.

Testimony and Public Comments

• A Regulatory Sandbox in Ohio Can Promote Innovation and Regulatory Reform. Written testimony by Agnes Gambill West submitted to the Ohio House Financial Institutions Committee in relation to Senate Bill 249.
• The FDIC Should Restore the OSA or, at Minimum, Solicit Public Views before Regressing to the SARC. Public comment by Thomas Hoenig and Brian Knight in response to the FDIC’s proposal to amend its Guidelines for Appeals of Material Supervisory Determinations

November FinReg Roundup was originally published in FinRegRag on Medium, where people are continuing the conversation by highlighting and responding to this story.