The Federal Reserve’s first, foremost function is best summarized on the Fed’s own website: “promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy” through monetary policy. Its critically independent mission does not include tinkering with the executive branch’s lawful functions or going it alone on reforms that elected officials are pursuing in good faith. Unfortunately, some at the Fed don’t seem to appreciate the difference, and they are reportedly days away from making an ill-advised decision that could adversely affect consumers, small businesses, and taxpayers.
On June 25 and 26, the Fed, along with the Federal Deposit Insurance Corporation (the Office of the Comptroller of the Currency is expected to follow) will propose changes to a rule known as the supplementary leverage ratio (SLR). While technical in nature, this rule carries major consequences for the federal budget, the cost of credit, and the economy given that Treasuries serve as a benchmark for most interest rates across that economy.
Yet, even with so much riding on getting SLR policy right, the Fed has opted to work largely in isolation rather than coordinate with Treasury Secretary Scott Bessent and the White House’s economic policy team. It has refused to submit regulatory proposals for the standard executive branch review process and has postponed important changes that would strengthen the financial system.
To be clear, the Fed’s monetary policy independence is vital, and must be safeguarded. When it comes to regulatory policy, however, collaboration with the executive branch is not only normal, it is expected.
Under current SLR policies, banks are required to hold the same amount of capital whether they buy a U.S. Treasury bond or make a high-risk loan. Capital cushions are essential to protecting taxpayers, but the SLR approach creates distortions. When serving as a Fed Governor, current Fed Chair Jerome Powell noted that a “risk-insensitive leverage ratio . . . can have perverse incentives.”
This is not an abstract concern. The national debt has now passed $36 trillion. The Treasury regularly sells massive volumes of bonds to keep the government running, and banks are a major buyer. If they’re penalized for holding Treasuries, they will stop buying Treasuries. As a result, either yields will go up and taxpayers foot a bigger bill, or the Federal Reserve will have to step in and undermine the free market. Under either scenario, Americans lose.
Secretary Bessent has proposed a practical solution: stop including Treasuries and central bank reserves in the leverage ratio calculation, as regulators did to stabilize the economy during the pandemic. According to Secretary Bessent, fixing this rule could bring down Treasury yields by 30 to 70 basis points. Every basis point translates into roughly a billion dollars in savings on debt service.
Recent reports suggest the Fed isn’t going to take the direct route. Instead of implementing the fix, it seems poised to offer a half-step—preserving the core problem while adding layers of complexity. Banks would still face barriers to holding Treasuries, and the government would still pay more than it should to finance its debt.
Even Daniel Tarullo, a former Fed governor not known as a laissez-faire regulator, has acknowledged the flaw. In a recent Brookings Institution paper, he conceded that the leverage framework constrains market liquidity, but opts for a less-than-clean fix. The Fed seems to be leaning in the same direction.
This debate is not about recklessly rolling back regulation. It is about making such regulation more accurate and more aligned with actual risk. Capital rules should not punish banks for holding the very assets the system is designed to rely on during periods of stress. Furthermore, a smart system of capital requirements that better measures safety and soundness risk also better protects taxpayers.
The upcoming SLR reform presents a clear opportunity. The Fed can correct a known flaw, improve market efficiency, save taxpayers billions, and keep systemic soundness strong. Or it can leave structural problems in place and miss the chance to lead, in cooperation with the executive branch and even Congress.
If the Fed is serious about efficiency, stability, and sound markets, this should be a straightforward call. Let’s hope it gets it right.