WASHINGTON Banks and their regulators are bracing for harsh, across-the-board federal budget cuts set to go into effect next week unless Congress manages to pass another last-minute fiscal deal.
The $85 billion in spending reductions this year mostly targets other areas, like defense, education and health care spending, but the financial services industry is not immune.
The Securities and Exchange Commission and the Commodity Futures Trading Commission, for example, would face millions of dollars in cuts at a time when both agencies are struggling to implement key aspects of the Dodd-Frank reform law.
"You'll see Dodd-Frank rulemaking from the SEC and CFTC slowed to an even more tedious pace," said Isaac Boltansky, a policy analyst at Compass Point Research & Trading. "They're already struggling with the capacity to implement Dodd-Frank and other Congressional mandates."
The heads of both agencies raised concerns about whether they have adequate resources to write new rules and police the industry effectively at a Senate Banking Committee hearing earlier this month, though neither referenced the sequester specifically.
The White House's Office of Management and Budget estimated last year that the SEC could lose an estimated $108 million from its current $1.3 billion budget, along with cuts to its smaller reserve and investor protection funds, even though the agency is deficit neutral because its funds are matched by collected industry fees. The CFTC could lose $17 million from its existing budget of $205 million, along with a reduction to its consumer protection fund, according to the report. (Actual cuts for this year may end up smaller than earlier estimates, as reductions were initially scheduled to start Jan. 1. Congress delayed them by two months when it addressed the so-called fiscal cliff last month.)
Both agencies are still working to finalize a host of derivatives rules under Dodd-Frank's Title VII and parts of the Volcker rule along with other regulators. The SEC also continues to finalize regulations for credit rating agencies and the registration of municipal advisors.
The process of planning for sequestration can also slow down regulators' work before any budget cuts are felt.
"The amount of time, money and resources that go to figuring out contingency plans and staffing patterns and conversations with staff on shutdowns and sequestration are major drains on productivity for the entire federal government," said Aaron Klein, director of the Financial Regulatory Reform Initiative at the Bipartisan Policy Center. "People are worried about pay cuts and layoffs. This uncertainty really hangs over you, and it has really undefined deleterious effects."
Other agencies may also be affected at least on paper.
The OMB report noted that the Consumer Financial Protection Bureau would be subject to $34 million in cuts over the full year from its estimated fiscal year 2013 budget of $448 million. This is despite the fact that the bureau's funding comes as a transfer from the Federal Reserve, and thus is not appropriated by Congress.
Observers said it's likely that cuts to the consumer agency are included because OMB considers that transfer of funds to the agency as subtracting from excess profits the Federal Reserve returns to the Treasury Department each year.
The OMB also estimated that the Federal Deposit Insurance Corporation's Orderly Liquidation Fund would lose $115 million from its budget authority of $1.5 billion. But sources said those figures may not point to actual spending cuts, and are likely based on a disputed projection by the Congressional Budget Office that the FDIC's authority to wind down big banks would cost the government billions over the next decade, assuming a large institution fails. The OLF does not spend money unless a bank fails, and those funds are ultimately paid by the industry, not taxpayers.
"Keep in mind the whole sequestration is a suspension of reality, it's all cuts to an imaginary baseline," said Mark Calabria, director of financial regulation studies at the Cato Institute. "So to the extent that an estimate is built into that baseline, you can cut that baseline and claim savings even if the actual spending was unlikely to ever happen."
Democrats and Republicans on Capitol Hill, meanwhile, remain deadlocked on the issue, with few predicting a deal before the sequester goes into effect March 1. The White House hammered Congress on Tuesday for failing to replace the "arbitrary" cuts with more "sensible" reforms.
"And by the way, the whole design of these arbitrary cuts was to make them so unattractive and unappealing that Democrats and Republicans would actually get together and find a good compromise of sensible cuts, as well as closing tax loopholes and so forth," said President Obama in a speech. "And so this was all designed to say, 'We can't do these bad cuts. Let's do something smarter.' That was the whole point of this so- called sequestration. Unfortunately, Congress didn't compromise."
Obama also called Republican leaders on Thursday to discuss the sequester, but it's unclear whether those discussions will prove fruitful. The Senate is expected to start considering bills to avert the cuts starting next week, according to press reports.
Analysts said that should the wide-ranging budget cuts go into effect, they are primed to hit certain local markets hardest, which could affect banks operating in those regions.
"For banks that are doing business in Northern Virginia, inside and around the beltway, there's an economic impact. If defense contractors start to feel the pinch, it can have a cascading effect on the local economy and on loan demand," said Brian Gardner, a policy analyst with Keefe, Bruyette & Woods. "On a more national level, I think the impact will be muted."
Gardner added that other regional economies tied to the Defense Department, such as California, and Washington State, which has a big aerospace industry, could also be affected, as could banks in those regions.
Yet others, including the White House, are predicting that the overall impact of the budget reductions will be felt more broadly.
"These cuts are not smart, they are not fair, they will hurt our economy. They will add hundreds of thousands of Americans to the unemployment rolls," Obama said during Tuesday's remarks. "This is not an abstraction, people will lose their jobs. The unemployment rate might tick up again."
Analysts added that the spending reductions come at a perilous time, as the economy shows early signs of recovery.
"I think there is a macro impact that isn't being priced in at the moment. It seems like we are finally at a point where this is a sustainable recovery, and the budget sequester would push growth below 2%, which would be an undeniable negative for what otherwise looks like a pretty positive landscape," Boltansky said.
Ongoing political gridlock over fiscal issues also erodes consumer confidence, which plays a key role in lending activity, said Albion Financial's Jason Ware.
"It puts a leash on animal spirits," he said. "The more they fiddle around and the more they fight, the worse confidence gets. It's that loss of confidence that puts the brakes on business and consumer activity and that directly impacts the lifeblood of banks."
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