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Treasury Nominee Could Have Far-Reaching Effects

Treasury Secretary nominee Steve Mnuchin, a former head of Goldman Sachs’ mortgage-backed securities desk, banker, hedge fund manager and film financier, was no doubt a strange choice for a candidate who bashed Wall Street on the campaign trail and warned that Goldman Sachs controlled rivals Ted Cruz and Hillary Clinton. He also represents a sea change for a federal government that has regulated banks more stringently in the wake of the financial crisis and focused on limiting corporate tax avoidance over trimming rates.

Mnuchin, who helped form OneWest Bank from the remains of IndyMac Federal Bank in 2009 before selling to CIT Group in 2015, has touted his experience in regional banking and singled out the “parts of Dodd-Frank that prevent banks from lending” for dismantling. Mnuchin has also stated that the Volcker Rule, created to prevent banks from making the types of speculative investments that contributed to the financial crisis, “is too complicated and people don’t know how to interpret it.”

Following The Lead Of The GOP Congress

Taking the perceived shackles off banks will clearly be a high priority for Mnuchin and the incoming Trump administration but industry observers still expect modification of Dodd-Frank versus outright repeal. Those efforts will be spearheaded by the GOP Congress, whose plans will no longer contend with an Obama veto. Earlier this year Congressman Jeb Hensarling, chairman of the House Financial Services Committee, introduced legislation which would roll back Dodd-Frank by allowing banks that elect to hold higher capital levels to be exempt from certain requirements. Banks would need to have a composite CAMELS rating of 1 or 2, reflecting satisfactory performance and risk management practices that provide for safe operations, and maintain a 10 percent non-risk weighted leverage ratio, a measure of capital held by a bank against its total assets. This is significantly higher than the 6% leverage ratio that banks are currently required to meet. As Bloomberg's Elizabeth Dexheimer observed, "passing Hensarling’s bill wouldn’t necessarily free large banks from the handcuffs Washington put on them after the financial crisis, unless lenders want to take the unappealing step of raising hundreds of billions of dollars in new capital." Hensarling's legislation would also repeal the Durbin Amendment, a provision limiting how much banks can charge retailers for debit card processing.

On December 1, the House voted in favor of the Systemic Risk Designation Improvement Act, replacing the $50 billion asset threshold in Dodd-Frank that regulators use to designate systemically important financial institutions (SIFI) subject to enhanced oversight. Republicans insist that decisions on what institutions are deemed systemically important should not be based on asset size alone. As the head of the Financial Stability Oversight Council (FSOC), the organization of financial regulators created by Dodd-Frank to identify and address systemic financial risks, Mnuchin could wield significant influence, particularly in how nonbank financial institutions — such as asset managers — are evaluated. "He could basically shut down the FSOC designation process," Dennis Kelleher, head of the financial reform group Better Markets, told Politico.  "What any Treasury secretary could do is direct the FSOC staff to look at nonbank threats in such a rigorous, onerous way that virtually no entity would ever be designated again."

Government To Sell Fannie Mae & Freddie Mac Stakes?

Fannie Mae and Freddie Mac, government-sponsored enterprises (GSEs) which were created to make it easier for borrowers to get mortgages, were placed under federal control during the financial crisis. Both ran into problems as the housing bubble burst and borrowers defaulted on their mortgages, with the federal government ultimately investing $187.5 billion to bail them out. While the two had returned $246.7 billion to government coffers as of August and produced a $10 billion profit under the most adverse scenario of Dodd-Frank stress tests, Mnuchin wants to “get them out of government control.” Mnuchin added, “We’ll make sure that when they’re restructured, they’re absolutely safe and they don’t get taken over again.”

His remarks sent shares of publicly traded Fannie (FNMA) and Freddie (FMCC) soaring more than 30 percent last Wednesday, although their market caps — $4.2 billion for Fannie, $2.3 billion for Freddie — are still a fraction of their peak. At the end of 2006, Fannie Mae alone had a market capitalization of $57.7 billion.

Gretchen Morgenson of the New York Times wrote that Mnuchin’s remarks represented “good news for small lenders who rely so heavily on Fannie and Freddie to buy the mortgages they underwrite, freeing them to repeat the process rather than hold the loans on their balance sheets. And when small lenders benefit, borrowers do, too, by having more choices.” Glen S. Corso, executive director of the Community Mortgage Lenders of America, said his organization has been “advocating for the GSEs to be reformed, recapitalized and then released from conservatorship. We’re hopeful that is the direction the Trump administration will head in.” Politico's Danny Vinik notes that it won't be entirely up to Mnuchin as the conservator — the Federal Housing Finance Agency — would also have to agree to any deal and the term of its current head, Mel Watt, does not end until January 2019. "Unless Watt leaves early, Trump won't be able to install a favored person at the agency for a few years," writes Vinik.

Corporate Tax Reform Triggers Debate Around Incoming Revenue, Looming Debt

Apart from regulatory change, Mnuchin has focused his attention on tax reform. Mnuchin has predicted “the largest tax change since Reagan,” with the aim of cutting the corporate tax rate from 35 to 15 percent. “We think by cutting corporate taxes we’ll create huge economic growth,” said Mnuchin, who believes that “we can absolutely get to sustained 3 to 4 percent GDP” growth, a figure not achieved in back-to-back years since 2004-2005 and not achieved by an administration since Bill Clinton’s second term. “And we’ll have huge personal income. So the revenues will be offset on the other side.”

The revenue forecasting that Mnuchin describes hinges on dynamic scoring, a technique allowing policymakers to account for the greater economic activity potentially spurred by these tax cuts. Jared Bernstein, a former chief economist to Vice President Biden and a senior fellow at the Center on Budget and Policy Priorities, has described dynamic scoring as a means “to generate implausible results about the extent to which big tax cuts will generate growth that will in turn pay for those tax cuts.” The conservative Tax Foundation’s analysis of the Trump campaign plan found that even with dynamic scoring the plan would reduce federal revenue by $2.6 trillion to $3.9 trillion over the next decade. It would “increase after-tax incomes for all income groups but reduce revenue to the Treasury,” wrote the Tax Foundation.

The nonpartisan Committee for a Responsible Federal Budget has concluded that Trump’s proposals, including tax cuts and infrastructure spending, would boost the nation’s debt by $5.3 trillion. Perhaps mindful of these challenges, Mnuchin has signaled that he’ll explore issuing debt maturing in more than 30 years. While acknowledging that “interest rates are going to stay relatively low for the next couple of years,” Mnuchin predicts that “eventually we are going to have higher interest rates, and that’s something that this country is going to need to deal with.”

A Legacy Not Without Critics: Foreclosures And Profits On The Back Of The FDIC

According to a redlining complaint filed by two fair housing advocacy groups with the Department of Housing and Urban Development last month, OneWest and its parent company, CIT Group, kept bank branches out of non-white neighborhoods and issued significantly fewer mortgages to minorities. While the complaint did not name Mnuchin, it could present a speedbump during confirmation hearings, along with revelations that OneWest aggressively foreclosed on delinquent mortgage borrowers. The California Reinvestment Coalition, a housing advocacy group, reports that since 2009 OneWest has carried out 36,000 foreclosures in California alone.

The terms of the purchase of IndyMac assets from the FDIC could also raise eyebrows. The FDIC seized the lender in mid-2008 and “spent months trying to find a buyer to recapitalize it,” reported Zachary Mider of Bloomberg. “No banks would touch it. Mnuchin’s investor group agreed to put up $1.55 billion only after accepting an offer from the FDIC to bear some of the future losses of the loan book.” The California Reinvestment Coalition told Bloomberg that loss-sharing payments to OneWest, related to IndyMac and another bank Mnuchin’s group purchased, had reached more than $1 billion as of September 2014.

While the FDIC’s losses were sizable, Mnuchin and his fellow investors sold OneWest to CIT for $3.4 billion, more than double what they paid for IndyMac’s assets in 2009. “Mnuchin may have personally gotten more than $200 million in proceeds from the sale, according to Bloomberg calculations. That doesn’t count any dividends or payments he might have received as chairman and chief executive officer of OneWest’s parent company,” wrote Mider. Senator Elizabeth Warren (D-Mass) said Mnuchin “spent two decades at Goldman Sachs helping the bank peddle the same kind of mortgage products that blew up the economy and sucked down billions in taxpayer bailout money before he moved on to run a bank that was infamous for aggressively foreclosing on families.”

Regardless of the fiery objections to Mnuchin’s past, it’s unlikely that his nomination will be spiked. While Warren has made her mark on Treasury, helping to prevent the seating of Antonio Weiss as Under Secretary for Domestic Finance, the chances of duplicating that feat are small. As of 2013, only 9 presidential nominees for cabinet positions had been rejected by the Senate and only 12 were withdrawn before coming to a vote. The last Treasury nominee rejected by the Senate? James S. Green, who was put forth by President John Tyler in 1844. Plan on seeing Steve Mnuchin in Washington.