SCOTUS Won’t Shut Down, But It Could Make Shutdowns Scarier
A government shutdown is brewing. Federal funds for many activities will dry up at midnight on Sunday, Oct. 1. Oral arguments at the Supreme Court in CFPB v. CFSA come two days later, on Tuesday, Oct. 3.
Why can the Supreme Court function while other federal activities stop? It, like the Consumer Financial Protection Bureau and other federal agencies and programs, has a measure of stable funding outside the annual drama of congressional appropriations. No wonder the former Republican FDIC chair Sheila Bair delivered this warning in a Politico op-ed:
“Imagine the dysfunction if the Fed’s budget could be held hostage to congressional dissatisfaction over interest rate policy, or if a member of Congress unhappy about a failed bank in his district could try to block the FDIC’s budget. Individual agency budgets could be put at risk by disgruntled politicians or lobbying interests.”
The case, brought by the payday lending industry lobby, hinges on an unprecedented interpretation of the Appropriations Clause that calls into question the CFPB’s secure, stable funding mechanism – one that the Federal Reserve shares. If the Court rules in favor of payday lenders, “the gears behind important financial regulatory and rulemaking work would grind to halt any time Congress reached a budgetary impasse,” AFR’s Elyse Hicks underscores.
Conservative skepticism about administrative agencies has given way to Trumpist fanaticism about the “administrative state,” a phrase popularized by alt-right guru Steve Bannon, and took legal form in the Fifth Circuit’s decision to invalidate CFPB funding. Bloomberg suggests the Roberts court has “lost control over the scope and pace of disputes” on executive agencies, as the time the Court spends on such cases grows. Meanwhile…
Over 40 organizations have called for Justices Clarence Thomas and Samuel Alito to recuse over connections with parties who would gain from a ruling against the CFPB.
The first head of supervision at CFPB, Steven Antonakes, warns that the agency’s already relatively small examination capacity would shrink due to volatile funding, potentially leading to a lax regulatory environment for the largest banks and nonbanks and needlessly burdening smaller institutions.
A group of fintech firms and the National Community Reinvestment Coalition, have expressed support for the regulatory stability afforded by the current CFPB.
A coalition of 20 national military and veterans service organizations have called for the court to reject the Fifth Circuit decision and uphold the agency’s capacity to protect current and former servicemembers and their families from abuse.
Despite the far-reaching ramifications of an unfavorable ruling and the chaos that could ensue, the question at hand boils down to a much simpler question posed by The Boston Globe: In a fight between a system-stabilizing agency that stands up for consumers, and predatory payday lenders, “Will the Supreme Court side with loan sharks?”
(If you need to play catchup on CFPB v. CFSA, a memo from AFR.)
FINANCIAL STABILITY: Executive Compensation – SAFER Banking – Shutdown and Regulators – JPMorgan and Epstein – Banking Access – Further to the Banking Crisis – Rates and Recession – FedWhen?
CONSUMER: Illinois Pawnbroker Loophole – Consumer Stats
PRIVATE MARKETS: An Anesthesiology Monopoly – Shadow Banks – Treasuries, Hedge Funds and Risky Companies – Citadel’s SEC Probe – Other PE News
CRYPTO: Binance Meltdown – Crypto’s Access to Government – A Bank-Sinking Crypto Scam
HOUSING: CFPB Mortgage Report
CLIMATE AND FINANCE: Climate Disclosures – Flood Insurance
Feedback? Reach us at afrnews@ourfinancialsecurity.org
FINANCIAL STABILITY
Executive Compensation.
AFR and 12 other organizations expressed support for the RECOUP Act, legislation that would make it easier for regulators to hold executives at failed banks accountable and prevent the excessive risk-taking that topples their institutions in the first place. The Act would allow regulators to bar executives from taking jobs in the industry, bolster governance and accountability standards, expand the FDIC’s clawback authority, and empower the FDIC to levy fines against executive wrongdoing. The cherry on top: it would be a step against dangerous, outsized bank consolidation by limiting the circumstances through which a large bank can scoop up a small one. Reads the letter:
“Executives should not be allowed to walk away with millions after they run their banks into the ground and put consumers, depositors, and our financial stability at risk. They must be held accountable. [They] should not be allowed to walk away with millions after they run their banks into the ground and put consumers, depositors, and our financial stability at risk.”
SAFER Banking.
On Wednesday, Senate Banking advanced by a 14-9 vote the SAFER Banking Act, an updated version of the cannabis banking bill that includes regulator-empowering changes in response to contentious Section 10 discourse, which would have made it more difficult for regulators to keep banks from doing businesses with certain customers. Despite middling bipartisan appeal seeing it successfully through Committee, Politico reports some Republicans remain skeptical over the Section 10 provision, as they suggest it wouldn’t be strong enough to “protect firearms, energy and crypto businesses” as well. Some Democrats, meanwhile, are interested in extending cannabis-related protections; Sen. Schumer indicated he would pair the Act with another bill that would create grants to help expunge cannabis records at the state level.
Shutdown and Regulators.
The government may shut down on Sunday, Oct. 1, momentarily depriving many federal entities of the funds they need to operate. That includes financial market regulators like the SEC and CFTC, but not banking regulators like the Fed and FDIC. The agencies in the latter group fund themselves outside of annual appropriations. Market regulators, meanwhile, must shut down when the government does – even without their watchdogs, the markets continue to operate. On Wednesday, SEC Chair Gensler warned the potentially impending shutdown would reduce staffing to “skeletal” levels, urging companies that wanted to go public to do so before today since his agency wouldn’t be able to perform functions like approving IPOs, considering capital raising filings or writing rules.
JPMorgan and Epstein.
JPMorgan will pay $75mn to settle a lawsuit related to its role as a “financial conduit” for sex-trafficker Jeffrey Epstein. Previously, Wall Street on Parade published an investigation on “relationship managers,” responsible for maintaining these institutions’ most dubious ties – from crypto heads to foreign dictators. JPMorgan reportedly had a relationship manager to oversee Epstein’s accounts. In total, the bank has agreed to $365mn in settlements related to the association.
Mayra Rodriguez Valladares suggests JPMorgan’s example “won’t teach banks a lesson,” as the aggregate payout is a drop in the bucket for multi-trillion-dollar banks like these and the loss of millions to “operational risk” every year is par for the course. She calls for updates to operational risk rules, “the most neglected part of overall risk management,” that would equalize how institutions manage risk and more easily identify money laundering and human trafficking. Incoming Basel III rules include provisions to improve the efficacy of operational risk management.
Banking Access.
The Economic Mobility Project hosted an event exploring “Minority Owned Banks and Banking Access in Minority Communities,” which examined the disappearance of physical bank branches in Black and Latino communities and highlighted the importance of their presence for persons who “lack financial resources, internet access, or transportation.” One highlight: Chicago Fed research found that low-income and Black households were less likely to visit bank branches than higher-income and White counterparts, despite the fact that the former more heavily rely on them. Generally, low-income communities had better access but lower demand (in fact, doubling income actually lowers that demand by about 7%), while Black communities typically had lower access but higher demand. The prevailing issues preempting people from visiting their local branches, however, varied between neighborhoods.
Further to the Banking Crisis.
The Fed’s Office of the Inspector General (OIG) issued its Material Loss Review of Silicon Valley Bank report this week. It outlines several reasons for the bank’s collapse: a concentration of uninsured deposits and irregular cash flow, major unrealized losses on securities, excess risk-taking, and inadequate communication from management about the bank’s “financial moves.” The report also holds the San Fran. Fed accountable for a “supervisory approach [that] did not evolve with SVB’s growth and increased complexity.”
Rates and Recession.
The Richmond Fed’s CFO Survey finds that, for the first time in over a decade, bank executives considered monetary policy their “most pressing” concern, as high interest rates have impeded their institutions’ spending plans. Forty percent of respondents reported they’ve had to pull back on capital and non-capital spending. However: a third of respondents said changing rates have had no impact; they don’t finance through borrowing, or their borrowing doesn’t budge because of rates.
FedWhen?
Even with the introduction of FedNow, most banks aren’t currently racing to use instant payments systems. Only 13% of respondents in a Bank Director survey say they’ve incorporated real-time payment (RTP) into their services. Many banks are pleased with their daily batch payments processing and may be unwilling to upgrade their tech to make RTP happen. And demand from commercial customers has so far been low.
CONSUMER
Illinois Pawnbroker Loophole.
Two years ago, Illinois signed into law the Predatory Loan Prevention Act (PLPA), legislation that would cap APRs at 36%. In that time, it’s saved local communities millions of dollars in fees and interest. One circuit court judge, however, granted pawnbrokers, which loan people money and use their possessions as collateral, an injunction that allowed them to continue lending at rates as high as 243.3%. The pawnbroker lobby now wants to make it official by codifying it in law. The American Fintech Council and Woodstock Institute now call for the legislature to uphold the PLPA and close the loophole.
Consumer Stats.
A couple of consumer stats:
Only the wealthiest 20% of American households still have the excess savings they accumulated during the pandemic. For the bottom 80%, liquid assets were lower in June 2023 than they were in March 2020.
On October 1, student loan repayments will start back up. That could “divert up to $100 billion from Americans’ pockets over the coming year.” The Biden administration is working to negotiate rulemaking that would secure support for borrowers.
PRIVATE MARKETS
An Anesthesiology Monopoly.
AFR-EF supports a recent move by the FTC to challenge private equity firm Welsh, Carson, Anderson & Stowe’s efforts to roll-up and suppress competition in the Texan anaesthesiology sector through their creation of U.S. Anesthesia Partners (USAP). USAP has cornered the market by buying almost every large anesthesia practice in the state, allowing their backers to broker price-raising agreements with the independent remnants. The FTC suit challenges their ability to create unfair market advantages. Says AFR-EF’s Ricardo Valadez:
“Private equity firms have long used roll-ups as a way to create market dominance in a local or regional market…While these practices are harmful in any industry, they are especially pernicious in healthcare and other instances, where patients often do not have an opportunity to shop around.”
Related to the healthcare industry: A new report from the Center for Economic and Policy Research examines the “financialization of home health care,” finding that large PE- and insurer-owned firms reduce competition and profit on the backs of Medicare recipients who will “pay the price in the future.”
Shadow Banks.
Not content with ensuring that massive banks have a lifeline at the central bank, the Bank of England is creating a lending facility that will aid shadow banks, the FT reports. Though there's no specific mention of private equity, hedge funds or many other "non-bank financial institutions," as they are known, this step would represent a gift of cheap money.
Treasuries, Hedge Funds and Risky Companies.
Treasury yields have surged to multi-year highs, 10-year notes at their highest in sixteen years, and shorter-term Treasuries at their highest in two, making stocks less appealing and increasing companies’ borrowing costs. Higher costs are “hurting riskier companies,” writes WSJ, particularly those that borrowed when rates were ultralow, via leveraged loans, to fund private equity buyouts. Now, $270bn worth of leveraged loans are at risk of default. One of their examples: Petco, backed by CVC Capital Partners in 2021, now paying 9% on a $1.7bn loan to pay down their debt burden.
High interest rates should be spurring a rash of bankruptcies by private equity-owned companies, but they’re shuttering at lower than expected rates (with the exception of bankruptcies like KKR-backed Envision Healthcare). Bloomberg explains that loans held by PE-backed firms don’t require imminent refinancing, and most leveraged loans are “covenant lite, meaning they contain fewer hurdles for borrowers to trip over, providing they keep paying interest.” Liquidity is the main issue for firms now. It is, they write, “dangerous to assume profits won’t deteriorate.” And private equity won’t always prop up struggling companies.
Related: WSJ reports on hedge funds’ “big bet against Treasurys.” They buy them, then bet against their futures to “take advantage of small differences in the securities’ prices.” Usually, they’ll borrow from large banks in overnight funding markets, creating extreme levels of leverage. That means that “unexpected shocks can force hedge funds to rapidly exit from their positions, sending shock waves through financial markets.”
Citadel’s SEC Probe.
Earlier this year, the SEC launched an investigation against the hedge fund Citadel, alleging “unmonitored communications,” according to Bloomberg. Regulators probed several hedge funds’ employees to examine “Wall Street’s use of unofficial messaging platforms like WhatsApp to conduct business.” Industry groups argue it’s an overstep by the agency, as Citadel is an investment adviser and subject to different recordkeeping rules than brokers. Now, the fund is gearing up for a legal fight.
Other PE News.
PE Drought. FT calls it this the worst third quarter for mergers and acquisitions since 2012, owing to a high interest rate environment and antitrust enforcement. And it’s the second year in a row that global M&A dropped by the double-digits, the first time that’s happened since the financial crisis. There are, however, still a few high-profile moves on the table, including Cisco’s largest acquisition ever.
Election Betting. Last week, the CFTC refused Kalshi’s proposal to allow investors, like hedge funds, to bet on the outcomes of U.S. elections. The Institute for Agriculture and Trade Policy applauds the decision.
Valuation. The Financial Conduct Authority, a UK watchdog, will launch a “sweeping review of valuations in private markets,” as regulators across the world become increasingly wary of the possibility of “blow-ups” in private asset markets.
CRYPTO
Binance Meltdown.
The crypto exchange Binance is “in distress,” reports WSJ, cracking under the threat of enforcement actions, an exodus of senior executives and layoffs to brace for a decline in business. At the beginning of the year, it handled 70% of trades where crypto was directly bought and sold; now, it handles 50%. In the U.S., activity has dropped to near-zero. One institutional investor told the WSJ that his firm was conducting “fire drills” to withdraw assets from Binance, as many companies fear a meltdown that would dry up market liquidity and cause token values to plummet. In Russia, the company is “set to fully exit the country” after having sold all of its Russian business to CommEX.
Crypto’s Access to Government.
Crypto chiefs and lobbyists used to be able to easily schmooze their way into meets with top regulators and other government officials. Since the collapse of FTX last fall, it’s gotten much more difficult for them to gain access. NYT reports Congressional offices hesitate to meet with industry reps, lobbyists can’t land meetings with regulators as often, and companies have had to “shift strategy” in an effort to set themselves apart from FTX. Says AFR’s Mark Hays:
“It has been quieter — and more circumspect, in some respects — but the push from the industry hasn’t abated…The crypto industry knows that its star has been tarnished on Capitol Hill, to some extent.” That said, Hays says that they’re still “getting doors opened” because “money talks.”
On Wednesday, a league of crypto executives swarmed the Hill as part of an advocacy campaign to push industry-friendly rules organized by crypto exchange Coinbase and its nonprofit Stand With Crypto. But, says Hays: “It's not clear to me whether the industry's efforts to bootstrap a crypto grassroots campaign out of nowhere is going to translate into something that's politically impactful."
A Bank-Sinking Crypto Scam.
Heartland Tri-State Bank, a Kansas-based lender with less than $140mn in assets, collapsed in July. It may be because its chief executive pumped money into a crypto scam, Bloomberg reports. After CEO Shan Hanes wired $12mn to an entity in Hong Kong, a client who declined to front any money to help reported it to the bank’s board. A representative escalated the issue to regulators, and soon the state’s Office of the Bank Commissioner declared the institution insolvent. While depositor accounts moved to Dream First bank, shareholders “face the possibility of losing everything they invested.”
HOUSING
CFPB Mortgage Report.
A new report from the CFPB finds that mortgages became much more unaffordable in 2022, while notably fewer mortgages were being originated, attributing the sharp changes to high interest rates. Some of the major findings: average payments increased more than 46%, and borrowers paid 22% more than in 2021 in costs and fees; most refinances (which dropped by about 73%) were cash-out refinances, which carry a much greater risk of foreclosure thanks to higher interest, higher payments and higher balances; and, more applicants were denied on the basis of their income. Hispanic and Black borrowers were hit hardest, often receiving the most denials, smaller loans, higher interest rates and higher upfront costs. Bloomberg’s Evan Weinberger observed that more mortgage rejections were the result of high debt-to-income ratios, an issue “that’s not getting better anytime soon.”
And: Home prices are also up, the Case-Shiller National Home Price Index reading 1% higher from a year earlier. Median sales prices ticked up almost 4% in August, from a year earlier.
CLIMATE and FINANCE
Climate Disclosures.
Sen. Warren sent a letter to SEC Chair Gensler demanding the agency work quickly to finalize rules that would mandate companies to disclose their climate transition risks and opportunities, including Scope 1, 2 and 3 emissions, energy plans and capital expenditures related to that transition. AFR has previously called on the SEC to do the same, requesting the agency not to shy away from Scope 3. Warren makes particular mention of private equity firms that especially seek to understate the emissions and present misleading information to investors. Says Warren:
Investors need credible financed emissions data to substantiate these types of claims and build a realistic picture of companies’ risks for accurate valuation of securities, and the SEC must use its existing guidance and authorities to scrutinize these types of omissions and discrepancies…The SEC in following its mandate to protect U.S. investors and provide critical information to U.S. investors, should consider within its economic analysis how these developments lower the cost of compliance of the proposed rule.
Flood Insurance.
Sen. Kennedy of Louisiana is working with House Republican leadership to extend the National Flood Insurance Program with a three-month reauthorization, since its lapsing would coincide with the start of a possible government shutdown, which would prevent the program from issuing new flood policies that “homebuyers and lenders need to close sales.”