Senator Mike Crapo Senator Sherrod Brown Chairman, U.S. Senate Committee on Ranking Member, U.S. Senate Committee on Banking, Housing, & Urban Affairs Banking, Housing, & Urban Affairs 534 Dirksen Senate Office Building 534 Dirksen Senate Office Building Washington, D.C. 20510 Washington, D.C. 20510

September 6, 2017

Dear Chairman Crapo and Ranking Member Brown,

In the decade following the worst financial crisis since the Great Depression, the memory of that economic calamity and its causes has faded for some policymakers in the GOP-led Congress and the Trump administration. The financial sector has seen healthy growth and continued profitability over the past several years—and has been in this state of comfort far longer than the everyday Americans who suffered during the recession. Despite a rapid return to profitability and significant improvements in the safety and soundness of the financial sector, there has been momentum over the past several months to undermine the progress made by financial reform efforts. Seven years since the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, financial reform remains just as necessary to promote a healthy and stable economy, a strong banking sector, and a level playing field for all participants in the financial industry.

On July 27, 2017, the U.S. Senate Committee on Banking, Housing, & Urban Affairs held a confirmation hearing for Randal Quarles, President Trump’s nominee to be the Board Vice Chair for Supervision.1 The professional track-record of Mr. Quarles—a self- described “Wall street lawyer for nearly 17 years,” senior Treasury Department official in the lead up to the crisis, and private equity buyer of distressed financial companies just after the crisis—is an odd one for a person seeking the Fed’s most important bank-supervisory position.2 Yet his answers to specific policy questions at the confirmation hearing provide little comfort to skeptics and raise serious concerns about his willingness to support strong and vigorous enforcement. The Center for American Progress recommends that Senators vote “No” when the nomination of Mr. Quarles is considered by the Committee.

The Federal Reserve Board Vice Chair for Supervision is an important position that has significant influence over the development and enforcement of a wide-range of financial regulations. Performing this task well can promote a healthy, fair, and competitive financial sector that benefits all Americans. The Vice Chair for Supervision at the Federal Reserve Board

1 U.S. Senate Committee on Banking, Housing, and Urban Affairs, “Executive Session and Nomination Hearing,” July 27, 2017, available at https://www.banking.senate.gov/public/index.cfm/hearings?ID=73257755-CECA-432A- B72E-DFA530DAC8CE. 2 U.S. Senate Committee on Finance, “Nomination of Randal K. Quarles,” March 21, 2001, available at https://www.finance.senate.gov/imo/media/doc/80413.pdf.

is a new, previously unfilled, position created by the Dodd-Frank Act to lead the Fed’s work supervising and regulating bank holding companies, savings and loan holding companies, and systemically important nonbank financial companies.

Since the financial crisis, the Federal Reserve Board, along with other financial regulators, has worked to develop and implement a much stronger financial regulatory regime, while preserving competition in the banking sector. From capital and liquidity requirements, to systemic risk oversight and stress testing, as well as a key role in multi-agency provisions such as the Volcker Rule, the Vice Chair for Supervision at the Fed will be responsible for maintaining and enforcing the pillars of the new financial regulatory structure, as well as developing some rules that remain unfinished. The financial crisis demonstrated how high the stakes are when regulating the financial sector. Weak regulation and lax oversight can have dire and lasting economic consequences for hardworking families and the overall health of the U.S. economy—ironically making the Federal Reserve’s monetary policy work that much harder. A successful candidate for this position should have a track record of public service, in which the candidate demonstrated clear support for strong financial regulations and financial sector accountability, and demonstrated an understanding of the importance of a more stable financial sector for all Americans.

Unfortunately, Mr. Quarles does not have a professional track-record that meets this standard. In 2006, when Mr. Quarles was the Under Secretary for Domestic Finance—one of the most senior positions in the Treasury Department—he stated that banks were “well capitalized” and that “Fundamentally, the economy is strong, the financial sector is healthy, and our future looks bright.”3 As Vice Chair for Supervision, Mr. Quarles would be arguably the most powerful financial regulator, with significant authority over bank capital requirements, stress testing, living wills, and more. The financial sector was not healthy in 2006 and banks were severely undercapitalized. The system was deeply vulnerable to a financial shock and when the dust settled on the 2007-2008 financial crisis, millions of jobs, homes, and trillions of dollars in wealth were lost.

Rather than raising alarms about the precarious state of the banking sector, Mr. Quarles left the Treasury and joined a global private equity firm team that invested in distressed banks. While there is nothing wrong with investing in troubled banks, there is something troubling about benefitting financially from a financial crisis that as a government official, he failed to see coming or act on. Mr. Quarles was certainly not the only former public official to be caught blindsided by the crisis. But in considering his nomination for the top financial regulatory post in the U.S., his record in the public and private sector should be carefully considered.

In addition to Mr. Quarles’ professional track record, his views on monetary policy and the post- crisis financial regulatory regime are crucial when evaluating his fitness for this position. As a voting member of the FOMC, Mr. Quarles will have considerable influence over the health of the overall economy. His previous support for a Taylor-type rule that would essentially put

3 U.S. Department of the Treasury, “Remarks of Treasury Under Secretary for Domestic Finance Randal Quarles to the Money Marketeers New York, NY,” Press Release, May 10, 2006, available at https://www.treasury.gov/press- center/press-releases/Pages/js4248.aspx. - 2 -

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monetary policy on auto-pilot is not sensible. As and others have pointed out, adherence to a would tie the Fed to a rule with numerous shortcomings – including problems related to measuring the “output gap”, assigning weights to both inflation and output gap variables, and identifying a real interest rate target – and foreclose the Fed from making the judgments required for effective monetary policy.4

Mr. Quarles also has expressed a desire to weaken financial stability regulations. At the nomination hearing, Mr. Quarles failed to provide the Committee with detailed answers on many important financial regulatory issues, and the limited viewpoints that he was willing to divulge were troubling. Mr. Quarles expressed his desire to increase “transparency” surrounding annual stress tests for banks, a policy endorsed in the recent Treasury Department report on banking regulation.5 As the former director of the Office of Financial Stability Policy and Research at the Federal Reserve Board discussed in a recent Brookings paper, this sort of stress testing “transparency” proposal is akin to giving banks the test beforehand—rendering it largely a useless exercise, especially if banks gain the ability to provide comment on the specifics of the test.6 The central value of stress testing is that banks do not have information about the test in advance because that mimics a financial shock, which is invariably a surprise. After all that the Federal Reserve and taxpayers did to rescue the banking system the last time it failed to see a crisis coming, pushing this sort of false “transparency” provision is akin to regulatory malpractice.

Moreover, when asked about his views on current bank capital requirements, Mr. Quarles offered no opinion. Banks are far better capitalized than they were before the financial crisis, but several recent studies suggest that current bank capital requirements are on the low end of what would be considered socially optimal.7 Banking industry groups, as well as the Treasury Department, have expressed a desire to change current leverage capital requirements—potentially lowering requirements for the largest banks by tens of billions of dollars each.8 It is unfortunate Mr. Quarles did not forcefully endorse strong capital requirements, given his pre-crisis error in assessing bank capital levels.

4 See Ben Bernanke, “The Taylor Rule: A benchmark for monetary policy?”, April 28, 2015, available at https://www.brookings.edu/blog/ben-bernanke/2015/04/28/the-taylor-rule-a-benchmark-for-monetary-policy/. 5 U.S. Department of the Treasury, “A Financial System that Creates Economic Opportunities: Banks and Credit Unions,” Report to President Donald J. Trump Executive Order 13772, available at https://www.treasury.gov/press- center/press-releases/Documents/A%20Financial%20System.pdf. 6 Nellie Liang, “What Treasury’s financial regulation report gets right—and where it goes too far,” Brookings, June 13, 2007, available at https://www.brookings.edu/blog/up-front/2017/06/13/what-treasurys-financial-regulation- report-gets-right-and-where-it-goes-too-far/. 7 Simon Firestone, Amy Lorenc, and Ben Ranish, “An Empirical Economic Assessment of the Costs and Benefits of Bank Capital in the US,” Finance and Economics Discussion Series, Federal Reserve Board, March 31, 2017, available at https://www.federalreserve.gov/econres/feds/files/2017034pap.pdf; Jihad Dagher et al., “Benefits and Costs of Bank Capital,” IMF Staff Discussion Note, March 2016, available at https://www.imf.org/external/pubs/ft/sdn/2016/sdn1604.pdf. 8 Gregg Gelzinis, “Treasury wants to weaken a crucial post-crisis capital requirement,” American Banker, June 20, 2017, available at https://www.americanbanker.com/opinion/treasury-wants-to-weaken-a-crucial-post-crisis-capital- requirement. - 3 -

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Finally, Mr. Quarles made it clear that he wants to simplify the Volcker Rule. But this effort should be viewed skeptically. Simplification has been an industry code word for loosening this crucial regulation. Any move to revise or simplify the Volcker Rule should not serve as cover to undermine the core principles or practical impacts of the rule. The Volcker Rule prevents bank holding companies and their affiliates from making swing-for-the-fence proprietary bets and from significant investment in or ownership of private funds. Since Dodd-Frank’s passage and the development and finalization of the Volcker Rule, banks have sold off their proprietary trading desks, reduced their capital entanglements with hedge funds and private equity funds, and have focused more on client-serving market-making activities. Recent academic research, as well as a congressionally-mandated report from the Securities and Exchange Commission, have found no evidence that the Volcker Rule or other financial regulations have hampered market liquidity.9

The Vice Chair for Supervision at the Fed is a position with important regulatory and oversight responsibilities for the U.S. banking system. A successful nominee for this position should have a clear track-record of supporting strong banking regulation and vigorous oversight, and should support the continued development and implementation of post-crisis financial reform efforts. The Vice Chair for Supervision must be an advocate for working class Americans, and weakening financial regulation, as Mr. Quarles appears to support, only makes them more vulnerable to another financial sector induced calamity. The Center for American Progress recommends that Senators vote “No” on the nomination of Mr. Quarles.

If you have questions regarding this letter or would like to discuss these issues further, please contact Gregg Gelzinis at [email protected].

Sincerely,

Marc Jarsulic /s/ Mike Madowitz /s/ Vice President, Economic Policy Economist Center for American Progress Center for American Progress

9 Marc Jarsulic, “Examining the Impact of the Volcker Rule on Markets, Businesses, Investors, and Job Creation,” Testimony before the U.S. House of Representatives Subcommittee on Capital Markets, Securities and Investment, March 29, 2017, available at https://financialservices.house.gov/uploadedfiles/hhrg-115-ba16-wstate-mjarsulic-20170329.pdf; Securities and Exchange Commission, “Access to Capital and Market Liquidity,” Report to Congress as Directed by Explanatory Statement to the Consolidated Appropriations Act, 2016 (P.L. 114-113), August 2017, available at https://www.sec.gov/files/access-to-capital-and-market-liquidity-study-dera-2017.pdf. - 4 -

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