Yellen Fed Guarantees Change in Bank Culture

NEW YORK ( TheStreet) -- President Obama will nominate Janet L. Yellen as chairwoman of the Federal Reserve on Wednesday afternoon, in a move that could signal continued change across the U.S. banking sector five years after the financial crisis and a rescue of the industry orchestrated by current chair Ben Bernanke.

What role Yellen will have in imparting change to the financial sector or what her overall policies will be is a matter of speculation, however, there are clear areas for investors and Fed watchers to consider.

The Federal Reserve is now the most forceful regulator of the banking sector and a crucial player in deciding how unfinished post-crisis reforms to the industry eventually take hold. While no single player at the Fed decides overall policy, it is generally understood that the chair sets the tone on what the central bank will treat as a priority.

In some respects, Yellen may push a more moderate set of policies than some may expect. While she may not favor a break-up of the nation's largest lenders, Yellen may push forward regulations that make size and complexity prohibitively expensive.

For instance, Yellen has been quoted as not favoring a re-implementation of the Glass Steagall Act, which would split apart commercial banking from investment banking. However, she does appear supportive of higher regulatory constraints on the leverage ratios of the large lenders that fall under the Fed's regulatory jurisdiction. In July, the Fed proposed a tier 1 capital leverage buffer of at least 2% above the a minimum leverage ratio requirement of 3% for the nation's largest and most interconnected lenders.

The matter of leverage ratios is of great importance for the biggest banks in the U.S. Rising constraints on leverage and increasing capital burdens on risk taking businesses, for instance, could force some banks to exit some businesses under their own accord. Under some strict constraints on leverage, analysts say only a few large lenders in the industry, notably Wells Fargo ( WFC), would be adequately capitalized in their current state.

Wells Fargo is a good starting point to think about Yellen's prospective tenure as Fed chair because the San Francisco-based lender has fallen under her purview for years in her role as president of the San Francisco Federal Reserve Bank. In that sense, Yellen's familiarity with the relatively staid business model of Wells Fargo vs. those of its larger investment banking peers such as JPMorgan ( JPM), Bank of America ( BAC) and Citigroup ( C) may be indicative of the change taking hold across the industry.

The Federal Reserve, in conducting annual stress tests, is now responsible for overseeing firms' financial planning and ensuring that lenders have the capital in place to weather a severe economic downturn similar to 2008 and 2009. In those stress tests, it is often Wall Street-oriented trading and proprietary investment activities that are treated as the riskiest and most burdensome to a firm's capital.

A continuation of strictly enforced stress testing could continue to propel banks to divest their riskiest assets as they look to free up their balance sheets to strengthen their lending to consumers and small businesses.

Such a scenario could, again, favor the business models of firms such as Wells Fargo over those with significant earnings streams from Wall Street. Recent stress testing, billions of dollars in asset divestitures and an emphasis by some firms on reducing their risk all indicate firms are moving in the direction of safety.

In that sense, Yellen's tenure could be a time when banks re-prioritize their Main Street lending capacities over their more glamorous Wall Street activities. Whether such a change results from Yellen's beliefs or, instead, the natural momentum of post-crisis regulatory policy may ultimately matter little.

For now, Yellen is likely to be seen as holding the Federal Reserve's more aggressive monetary policies in place and leaning toward an accommodating stance when it comes to setting interest rates.

"Yellen is unquestionably the best candidate. But there is a slightly bigger risk that under her stewardship, the Fed will fail to tighten monetary policy in time once the recovery gathers momentum, eventually triggering an unwanted surge in inflation," Paul Dales, Senior U.S. economist at Capital Economics said in a Wednesday note.

In September, the Fed was expected to begin paring down an $85 billion a month bond purchasing program designed to push down mortgage and long-term interest rates. Weak recent economic data, the shutdown of the U.S. government and looming uncertainty over the government's ability to service its debt, however, appear to have caused the Fed to hold steady on its bond buying.

Lawmakers will have to approve Yellen upon her formal nomination by Obama later this afternoon. While Yellen's previous confirmation as vice chair caused some rumbling among Republican senators who saw a dovish policy stance that could lead to inflation. Still, Yellen sailed through confirmation and it seems unclear what, if anything, has changed since.

"Putting aside the debate over philosophy and qualifications, we look at the raw political numbers and believe that Janet Yellen will be confirmed to be Fed Chairman," Brian Gardner, senior vice president of Washington Research at Keefe Bruyette & Woods, said in a client note.

Janet Yellen has deep experience with the Federal Reserve that goes back nearly two decades and includes a significant body of work under both Alan Greenspan and Ben Bernanke's leadership. She joined the Fed's board of governors in 1994 for a three-year tenure before onto the White House as a member of President Bill Clinton's Council of Economic Advisors from 1997 through 1999.

Yellen returned to the Fed in 2004 as president of the San Francisco Federal Reserve and was in the position during the later years of the housing bubble and the crisis, when Bernanke and other Fed officials devised a set of extraordinary measures to pump liquidity into the financial system and support the financial standing of large banks.

Her ascent continued in 2009 when she became a voting member of the Federal Open Market Committee and in 2010, President Obama when nominated Yellen as vice chair of the central bank.

Yellen is deeply familiar with the activities that promoted the housing bubble and the financial crisis. She has become enmeshed in the central bank's post-crisis regulatory response and is likely to eventually state a clear set of values that will govern her work as chairperson.

Obama's appointment of Yellen does break ground in putting a female at the top of the Fed -- generally thought of as the most important position in all of finance -- and it will be interesting to see if her nomination brings a new breed of women into top leadership roles in finance.

Currently, none of America's largest banks have a female CEO, however, some are beginning to speculate on possible successors to Jamie Dimon, the current chairman and CEO of JPMorgan. Were JPMorgan's legal issues to escalate, it wouldn't be surprising for discussion to center on Mary Erdoes, a wealth management executive, to be considered a possible successor.

Yellen's appointment by President Obama clearly marks a turning point for the Federal Reserve after two terms of leadership under Ben Bernanke. While the financial crisis prompted Bernanke and his peers at the Fed into unprecedented action, it may be Yellen's tenure where the industry truly changes.

-- Written by Antoine Gara in New York

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