In 2008, as the global financial system was melting down, America’s largest banks continued paying dividends.
Those shareholder payouts were made both by institutions that were holding up amid the storm, like Bank of America, and by companies that were teetering on the brink. Both Lehman Brothers and Merrill Lynch continued handing out piles of cash to prove that they were solvent.
They were not. And those payouts left them weaker, exacerbating shortfalls that would ultimately cause their demise.
As the coronavirus puts the financial system to its biggest test since 2008, there are growing concerns that the Federal Reserve is ignoring the costly and painful lessons of the last crisis by allowing banks to continue paying dividends.
While this crisis did not begin in the financial system, the virus is causing severe strain across various markets, and has at times made it hard to trade everything from corporate debt to Treasury securities. The Fed has rolled out programs to ensure that the inner workings of finance do not collapse and that banks can continue lending despite a severe downturn.
Officials have loosened post-crisis rules put in place to ensure that banks had big enough financial cushions to continue lending, alongside other accommodations. They have relaxed borrowing caps, encouraged banks to dip into their extra layers of capital and liquidity, and are offering up cheap funding programs, all in an effort to encourage banks to keep making loans.
Yet so far, policymakers have not stopped banks from continuing to pay dividends, allowing them to part with cash that could put them in a stronger position to continue serving as lenders and intermediaries should the unpredictable crisis deepen — though such curbs remain a possibility.
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“I don’t think that’s something that needs to be done at this point,” Chair Jerome H. Powell said during a Brookings Institution webcast on April 9. “We’ll be watching to see how things evolve, but I don’t think that step is appropriate at this time.”
Big banks have voluntarily suspended stock buybacks for the time being, but they are loath to halt dividends because doing so could signal that their firm is in bad financial shape.
Dividends at the biggest banks will probably amount to about $40 billion this year, according to estimates by Gregg Gelzinis, a senior policy analyst at the left-leaning Center for American Progress. While substantial, that is less than what they will retain by halting share buybacks.
If banks do not do any buybacks this year, it will probably give them an additional $150 billion in capital, he said. So far, they’ve committed to a two-quarter suspension, so are set to preserve about half that.
While Mr. Powell does not appear ready to impose restrictions, minutes of the Fed’s March 15 meeting show that some Fed officials believe the central bank should be making sure that firms hang on to all the cash that they can in an uncertain environment.
“Several participants commented that banks should be discouraged from repurchasing shares from, or paying dividends to, their equity holders,” according to the minutes, which were released last week.
And the Bank for International Settlements, which advises global central banks, said in a new brief that while a blanket restriction on payouts would “reduce banks’ attractiveness to investors,” it would also “limit the risk of signaling a bank’s relative weakness.”
Some former Fed officials agree that the central bank should consider constraining payouts.
“We learned that we let way too much money out the door in that crisis,” Janet L. Yellen, the former Fed chair, said of 2008. She hasn’t talked to Fed officials about their current thinking, but believes they should ask banks to halt dividends. “We don’t know where this is going, this is really a tail event and a great threat to the country.”
If the Fed halts dividends while banks are still functioning normally, it would come across as precautionary to investors, said Daniel K. Tarullo, a former Fed governor and a key architect of much of the post-crisis bank regulatory regime. If it waits to take that step further down the road, when signs of financial system trouble are mounting, it could instead be read as a signal of trouble.
“At the early signs of what could be a major challenge, that’s when you push the banks to husband their capital,” he said. “That is the time when it wouldn’t have been a signal and would instead would be regarded as a hedge.”
“It is disappointing that this is not the course the Fed has taken,” he said, adding that after the crisis, regulators learned that the “playbook” should be to suspend dividends and buybacks early.
Banking groups say there is no need to stop paying dividends since the sector is in much stronger shape than it was headed into the 2008 crisis.
“There’s no evidence of a need to suspend dividends based on the conditions of these institutions,” Kevin Fromer, head of the Financial Services Forum, an advocacy group for large banks, said in an interview last week.
Banks are already taking a beating amid the coronavirus pandemic. JPMorgan Chase & Company reported first-quarter earnings per share of 78 cents, less than half of what analysts were estimating, as reserve holdings mounted and markets gyrated. Wells Fargo’s earnings per share dipped to just 1 cent and it set aside more money for credit losses, it said Tuesday. But the firms do have more capital to get them through tough times than they did before the 2008 financial crisis, thanks to post-crisis regulatory changes.
Fed leaders have become more bank-friendly under the Trump administration, which, paired with the industry’s improved financial position, is probably driving the reluctance to cut dividends.
Instead of reining in payouts, Fed officials have actually made changes that allow banks to continue making them. Banks are generally allowed to dip into their capital buffers in times of stress, and are encouraged to do that to support lending and spending. But they avoid doing so, because it activates regulations that require them to cut dividends.
On March 17, the Fed said it would make those restrictions phase in more gradually to encourage banks to use the buffer.
Weeks later, the central bank’s Board of Governors in Washington said it would change a key regulation — the supplementary leverage ratio, which gauges capital held against assets — for a year. Banks are no longer required to count their holdings of Treasuries and cash deposits at the Fed toward the ratio, which will allow big banks to lower their capital by about 2 percent.
The Fed probably had to make some sort of leverage ratio tweak. The central bank is pumping reserves, bank holdings at the Fed, into the financial system as it makes giant bond purchases to smooth markets. That, paired with an influx of deposits as investors cash out their investments, has saturated bank balance sheets.
When banks hold too many assets (like Treasury bonds) relative to capital (common stock and retained earnings), they avoid taking on more and throwing their regulatory ratios out of whack.
In the current environment, that could disrupt markets. If banks are not willing to snap up Treasury bonds as the government unleashes a flood of them to pay for its $2 trillion coronavirus relief package, the Fed would have to buy bonds even more aggressively or risk a meltdown. If banks serve as go-betweens, holding the bonds for a time, Treasuries can find their way into household investment portfolios. Absorption is easier.
But the change gives big banks, which have long detested the leverage ratio, a major win. And while it is temporary, industry experts speculate that banks will push hard to make sure it never changes back.
There is clearly nervousness at the Fed that the newly free capital could be used to ramp up payouts. The central bank’s statement cautioned that the change was to allow banks “to serve as financial intermediaries, rather than to allow banking organizations to increase capital distributions.”
It said it will “administer the interim final rule accordingly.”
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