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Alexander William Salter and Thomas Hogan: Quit Playing Games with Bank Regulation

When politicians and regulators play games with bank supervision, ordinary Americans lose. The political contest over banking and financial regulation is heating up. What Columbia's Charles Calomiris and Stanford's Stephen Haber call the "game of bank bargains" is developing into a partisan tug-of-war. It matters little who wins, because the game itself is the problem.

Congressional representatives Mondaire Jones (D., N.Y.), Rashida Tlaib (D., Mich.), and Ayanna Pressley (D., Mass.) have introduced a bill, the Fossil Free Finance Act (FFFA), which would direct the Federal Reserve to limit bank lending for projects related to fossil fuels and greenhouse gases. The proposal would prohibit "new or expanded fossil fuel projects after 2022" and "the financing of all fossil fuel projects after 2030." Whatever the bill's merits, it significantly raises the stakes in the bank-regulation game.

Just eight months ago, government regulators were telling a very different story: that banks were not allowed to discriminate against entire sectors, such as the fossil-fuels industry. The Fair Access Rule, finalized in January under Office of the Comptroller of the Currency (OCC) director and Trump appointee Brian Brooks, was canceled by the Biden administration before going into effect. As Brooks said of the rule (apparently unironically), "We need to stop the weaponization of banking as a political tool." But as long as elected officials and bureaucrats treat banking regulation like a partisan football, the game will continue.

The proposed legislation and OCC's rule are directly at odds. While the FFFA would make it illegal for banks to lend to fossil-fuel companies, the Fair Access Rule would make it illegal not to lend to fossil-fuel companies. Policy reversals like this are bad for the economy, but that's not all that's wrong. Neither the proposed legislation nor the regulatory rule is based on sound risk-management practices. Both measures put politics ahead of economic and financial stability.

Politicized money and credit is bad news for the U.S. economy. Banks play a vital role in allocating scarce resources, including credit, to where they create the most value for consumers. When the banking system channels credit to investments that produce valuable goods and services in the future, we all become richer. Indeed, banking and financial markets are known to be important drivers of economic growth.

Political direction of credit throws a wrench in the economy's gears. Investment capital flows not to those who create wealth, but to those who have political pull. The financial system begins to allocate saved resources less efficiently, resulting in forgone growth. Politicians and the interest groups backing them benefit from this arrangement. Everybody else loses.

Political factors have waxed, and economic factors waned, in money and credit markets for more than a decade. It's not just regulation. Monetary policy, too, has become a political battleground. During and after the 2008 financial crisis, the Fed experimented with quantitative easing — outright purchase of non-traditional assets such as long-term government debt and mortgage-backed securities. While this gave markets a boost, it also opened the Fed's balance sheet to factional politics in Congress.

The Fed's response to the COVID-19 crisis raised the stakes even more. Its emergency programs included supporting the markets for corporate and municipal-government debt. These measures were intended to support the financial system, but politics soon trumped economics. For example, Senator Charles Schumer (D., N.Y.) encouraged the Fed to change the requirements for one of its programs so the New York Metropolitan Transportation Authority could participate. The more politics matters for who gets investment capital, the more of this behavior we'll see.

Don't take our word for it. Two former Fed chairs understood the dangers of political interference in credit markets and wisely resisted it. Ben Bernanke nixed the idea of the Fed bailing out General Motors. Janet Yellen, now treasury secretary, rebuffed calls from Congress for the Fed to prop up Puerto Rican debt. Although the Fed has become increasingly political, things would have been worse without their prudent stances. We should follow their principles and de-escalate political conflict over credit and investment.

The OCC rule and the FFFA proposed by Representatives Jones, Tlaib, and Pressley show that the stakes of politics are rising. Congressional and interagency battles over credit policy represent competing interest for an increasingly contested resource. While this might be rational for each of the parties involved, it can be enormously costly for the economy. Credit politicization is an arms race. "The only winning move is not to play."

The Fed and other bank regulators are tasked with limiting bank risk and ensuring the stability of the financial system. Goals that distract from those missions can only destabilize the U.S. economy. When politicians and regulators play games with bank supervision, ordinary Americans lose.

Mr. Hogan is senior research faculty at the American Institute for Economic Research (AIER). Mr. Salter is an economics professor in the Rawls College of Business at Texas Tech University and a senior fellow with AIER's Sound Money Project.

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Posted: October 6, 2021 Wednesday 06:30 AM