Bloomberg News
Six months ago, Michael Barr was setting the Federal Reserve’s regulatory agenda. Now he’s speaking out against it.
During a Wednesday morning event at the Brookings Institution, Barr — a governor on the Federal Reserve Board and the former Fed vice chair for supervision — warned about the risks “regulatory weakening” pose to the financial system, especially during economic booms.
In prepared remarks, Barr discussed how past eras of light bank regulation contributed to the Great Depression, the savings and loan crisis of the 1980s and the global financial crisis of 2008. During a moderated discussion after the speech, Barr said he is concerned about a similar calamity arising from the current period of regulatory reform.
“I certainly worry about that. You’ve seen me dissent in a couple examples of recent action by the Federal Reserve Board,” he said, highlighting a set of
Speaking with David Wessel, director of Brookings’ Hutchins Center on Fiscal and Monetary Policy, Barr said the Fed board is “responding to the current environment” by pursuing changes to the stress test that he believes will make it easier to game and therefore a less effective tool for identifying risks in the banking system.
“People are doing this for good, well-meaning reasons, but I am really worried that, over time, stress testing will become much less effective,” he said.
Barr
Recent weeks have seen Barr shift into Bowman’s previous role as the
The ratings proposal would enable banks to be deemed well managed even if examiners identify significant governance or controls issues. During Wednesday’s event, Barr said the changes amount to “grade inflation” by giving a seal of approval to banks that have significant operational risk exposures.
“Changing the grading, having grade inflation for banks, is not the way to make them safer,” he said. “And I’m, again, very worried that the proposal that was put out is basically just grade inflation. If you call a bank well managed and it has a serious deficiency in governance and controls, capital or liquidity, that’s not a well-managed firm.”
Barr added that remediating such issues often calls for more focused attention than management can provide during the ordinary course of business. Calling out deficiencies in an examination report, he said, puts focused attention on addressing them.
In his speech, Barr made the case that financial regulation has been relaxed during boom times throughout U.S. history. For example, the Great Depression, he said, was in part the result of regulators failing to keep up with the rapid pace of financial innovation during the 1920s. In other cases, such as the S&L crisis, he said, regulation was weakened through intentional policy rollbacks, or by an overreliance on markets’ self-regulation — as he said was the case in the lead up to the GFC.
Barr said it is important for the regulatory environment to evolve constantly. While sometimes that means removing outdated regulations or amending overly restrictive requirements, a careful balance must be maintained.
“While it is true that regulation must evolve with the economy and financial system, we need to recognize that relaxing rules can create vulnerabilities,” he said. “Changes in the markets themselves can also weaken the effectiveness of regulations.”
During his conversation with Wessel, Barr also discussed other recent developments that he sees running the risk of repeating historical mistakes, including stablecoins. Barr said he sees parallels between the emerging payment technologies and the wave of state bank-issued currencies in the 1800s that led to numerous bank failures and financial market stresses.
“We didn’t have a system for the transmission of money in our economy, and that was really only fixed with the creation of the National Bank Act and the creation of a uniform currency in 1863,” he said. “We overcame the problems of fractured private money systems, we established a national currency, we established a uniform currency at par, and there’s a tendency now to want to go back to the era of the 1830s that had some difficulties.”
Barr said he is glad to see lawmakers taking up the issue of stablecoin regulation, but added that he has significant concerns with the bills that are working their ways through the House and Senate. Specifically, he said the legislation would create insufficient federal oversight of the sector that could result in states crafting less stringent frameworks to attract large issuers. He also has concerns about coins being backed by assets such as uninsured bank deposits, repurchase agreements and other short-term funding instruments.
“There are serious issues here,” he said. “I think it’s better to have a framework than not to have a framework, but my best intuition is that in a couple years Congress is going to have to come back and revisit this question because there’s going to have been some significant problem in this sector.”
Barr also discussed the role and structure of the Fed’s vice chair for supervision. He said the position is important for keeping the central bank accountable to its regulatory obligations — pointing to his regular testimonials to Congress — but comes with limited authority. Specifically, he noted, the vice chair cannot enact any policies unilaterally, but rather must bring them before the full board for approval.
Barr acknowledged the creation of the position has contributed to more frequent “shifts in regulatory philosophy” at the Fed, but noted that such dynamics have been playing out across the bank regulatory landscape for decades.
“That’s really been true across the banking regulators for a very long period of time. We’ve seen swings in history back and forth and I’ve recounted some of them here today,” he said. “Bank regulation involves tradeoffs and those tradeoffs involve decisions about how much to worry about risk in the financial system as opposed to efficiency gains you might have in the shorter term and I think that’s appropriate for people to debate and disagree about.”
Asked whether he intended to remain on the board through the end of his governorship, which expires in 2032, Barr said he has no timeline in mind for his tenure at the central bank.
“I don’t have any plans to leave,” he said.