Here's Why WSJ's Fed "Power Shift" Is Meaningless

On Wednesday, WSJ’s resident Fed mouthpiece Jon Hilsenrath penned a piece that carried the following subheader: “Secret ‘Triangle Document’ gives control of big-bank regulation to committee.” 

Here’s an excerpt: 

The Federal Reserve Bank of New York, once the most feared banking regulator on Wall Street, has lost power in a behind-the-scenes reorganization at the nation’s central bank.

The new structure was enshrined in a previously undisclosed paper written in 2010 known as the Triangle Document.

Not only does that sound interesting, it sounds a bit like the plot of a House of Cards episode, so you can imagine our disappointment when, over the course of more than 2,000 words, Hilsy doesn’t really deliver on the headline’s promise. 

Here, in a nutshell, is the plot. In a tragic turn of events for firms who, whenever possible, like being regulated by the people they go to dinner with, Fed officials in Washington decided they wanted to play a larger role in regulating the nation’s most systemically important financial institutions, so they formed a D.C.-based committee to supervise the banks which meant that NY Fed officials and examiners no longer had carte blanche to supervise Wall Street. That’s it. That’s the whole story. 

And it might have been a half-decent story, were it not for that fact that it’s already been told. Here’s Bloomberg, circa 2011: 

Some of the biggest banks in America, such as JPMorgan Chase and PNC Financial Services, want to increase dividends over the next few quarters. When those dividends do go up, it will look like a vote of confidence by bank boards on the sustainability of economic growth and profits. The payouts will also be one of the most carefully screened moves by regulators in modern financial history.


The behind-the-scenes guiding hand of these bank board actions is a little-noticed team of economists, payment systems experts, bank examiners, and quantitative analysts at the Federal Reserve. The group was formed in early 2010 by Chairman Ben Bernanke and Governor Daniel Tarullo to hunt down risks in the financial system before they trigger another crisis.


Almost a year ago, the new Fed team, known as the Large Institution Supervision Coordinating Committee (LISCC)—which staffers pronounce "lis-sick"—helped Bernanke identify and respond to an emerging threat to the global banking system when U.S. money market funds began dumping European bank debt out of fear of a Greek default.


Before LISCC's creation, the Fed's 12 reserve banks handled much of the day-to-day supervision of big banks and reported back to the Board of Governors in Washington, which sets the rules for bank holding companies. With LISCC, the Fed can tap its deep bench of more than 200 PhDs to figure out how a particular risk might affect the entire financial system or just a single bank.

Of course if you didn’t get the story from Bloomberg more than four years ago, you could have also gotten it from the Fed’s own website. 

Via the Fed: 

To fulfill this mandate and to reorient its supervisory program in response to the supervisory lessons learned from the financial crisis, the Federal Reserve created the Large Institution Supervision Coordinating Committee (LISCC) framework. The LISCC is a Federal Reserve System-wide committee, chaired by the director of the Board's Division of Banking Supervision and Regulation, that is tasked with overseeing the supervision of the largest, most systemically important financial institutions in the United States.

The LISCC is comprised of senior officers representing various functions at the Board and Reserve Banks, bringing an interdisciplinary and cross-firm perspective to the supervision of these large, systemically important financial institutions. 

Nevertheless, all of the usual suspects picked up on the story (except Bloomberg presumably because they wrote about it three years ago) with CNBC and Reuters writing their own versions. The Journal’s only real contribution was to say that there was a document (which apparently was all of 6 pages) and to outline how tough this has all been on Bill Dudley. 

The larger story here is that LISCC and its chief Daniel Tarullo were supposed to represent a sea change in the way Wall Street’s most influential firms are regulated. That is, this was supposed to be a tougher regime than that which existed when the fox was guarding the hen house and the Fed’s stress tests were supposed to be one of Tarullo’s primary weapons in the fight to ensure TBTFs are sufficiently capitalized to withstand a systemic “shock.”  Here’s Tarullo himself on the subject (from a speech about how much safer we are now as a result of the stress tests): 

...supervisory stress testing has fundamentally changed the way we think about capital adequacy. The need to specify scenarios, loss estimates, and revenue assumptions--and to apply these specifications on a dynamic basis--has immeasurably advanced the regulation of capital adequacy and, thus, the safety and soundness of our financial system. 

This of course, has all proven to be largely a charade, as only four institutions have ever failed the Fed’s “strenuous” tests. It also seems like no coincidence that the Journal just happened to release this article — which purportedly chronicles the transformation of bank regulation from the Wild West days of NY Fed/ Wall Street canoodling to a brave new era of prudent supervision by Daniel Tarullo and a team of PhDs — less than 24 hours before the Fed released the results of this year's stress tests. Here’s Hilsenrath: 

The new structure will be on display Thursday, when the Fed releases results of annual stress tests of big banks, a program run out of Washington by Mr. Tarullo’s group.

It was on display alright, and while we’re sure the intention was to paint a fresh picture (no one likely remembers the Bloomberg article) of Daniel Tarullo and LISCC as the guardians of sound banking just ahead of the stress test results so that several hours later everyone who read the article would point to the fact that not a single bank failed and say “see, there’s the proof that the new system works,” anybody who knows anything about pyramided counterparty risk (i.e. rehypothecated collateral) knows that this entire enterprise is futile. In other words: 

...the test results are completely meaningless, as the Fed neither then, nor now, has any methodology for how to calculate capital in case of the same kind of counterparty failure chain as happened during Lehman, and when no amount of capital would have been sufficient to preserve the financial sector.

So in sum, nothing has changed here at all; the “new” regulators are just as inept as the “old” ones. The ultimate irony though is that the greatest risk to the financial system now resides not on Wall Street but comfortably in Washington, as Fed policy continues to distort markets by inflating asset bubbles and siphoning high quality collateral from the system.