Fed’s Barr Says Regulatory Weakening During Boom Times Lays The Foundation For Busts

Federal Reserve Governor Michael Barr on Wednesday emphasized the importance of ensuring regulations are robust enough to prevent economic downturns.

In a speech at a Brookings Institution event on Wednesday, Barr discussed the connection between regulations and the economic cycles of boom and bust.

“It is striking to see the pattern of regulatory weakening during a boom, including the failure of the regulatory environment to keep pace with the evolving financial sector, and how this weakening lays the foundation for a subsequent bust,” Barr said.

He added that while easier banking rules help drive risk-taking during economic booms, they also increase vulnerability, and a subsequent downturn makes the situation more painful.

“In principle, financial regulation should incentivize banks to engage in responsible risk-taking and build up resources in good times, so that they can deal with times of financial stress and continue their vital role in the economy in bad times,” he said.

While Barr appeared to criticize the easing of bank controls, he tempered his criticism by saying that this practice could appear justified when it is enacted.

He recounted a few examples from several periods of economic downturns, such as the Great Depression in the 1920s and 30s, the Savings & Loan crisis in the 1980s and 90s, and the Global Financial Crisis in the 2000s.

As for the lessons from these crises and the need for regulation, Barr said a “bit of humility would have helped.”

He concluded by saying that “policymakers should resist the pressure to loosen regulations or to refrain from imposing regulation on new activities during the boom times.”

Barr’s note of caution comes at a time when the Federal Reserve proposed to ease the enhanced supplemental leverage ratio in June. This applies to large banks, such as JPMorgan Chase, Goldman Sachs, and Bank of America, and proposes reducing the capital requirement ratio to 3.5% to 4.5%, from the existing 5%. 

Meanwhile, U.S. equities rebounded in Wednesday’s midday trading session as investors processed the better-than-expected results of big banks such as Morgan Stanley and Goldman Sachs.

The SPDR S&P 500 ETF (SPY) was up 0.18% at the time of writing, while the Invesco QQQ Trust (QQQ) declined 0.07%. Retail sentiment around the S&P 500 ETF on Stocktwits has been in the ‘neutral’ territory over the past week.

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