MEMORANDUM
TO: Investment Committee
FROM: Senior Economist
DATE: July 19, 2026
SUBJECT: Analysis of Recent Federal Reserve District Research
I have reviewed the latest output from the Fed districts. While there is a variety of academic exploration, the following publications are the most analytically significant for our current positioning and risk models.
1. [NY] Series on Nonbank Subsidiaries and Regulatory Arbitrage (Posts 1-3): This research reveals how Bank Holding Companies (BHCs) are using nonbank subsidiaries as "equity reservoirs" to bypass Basel III capital constraints. This suggests a hidden fragility in internal capital markets that could lead to sudden liquidity gaps during systemic stress, as capital is not where the risk is actually concentrated.
2. [NY] More Tariff Pass-Through Is in the Pipeline: The Fed finds that the initial absorption of new tariffs by corporate margins is ending, with a significant wave of price pass-through to consumers imminent. This implies a second wave of inflationary pressure that may force the FOMC to maintain a "higher for longer" stance despite cooling growth.
3. [NY] Effect of Tariffs on U.S. Small Businesses: Using 2025 data, this study highlights the disproportionate negative impact of trade barriers on small enterprises compared to multinationals. This signals a potential degradation in the "Main Street" economy and a rise in small-business credit defaults, which could stress regional bank balance sheets.
4. [NY] Using AI to Analyze 3,000+ Bank Runs: By applying LLMs to historical data, the Fed is refining its understanding of the triggers and contagion patterns of banking panics. This indicates that the Fed is actively upgrading its early-warning systems for systemic risk, which may lead to more aggressive (and potentially disruptive) regulatory interventions during the next liquidity crunch.
5. [STL] The Cost of Capital and Misallocation in the U.S.: This paper examines how inefficient capital distribution is dragging on potential GDP growth. For our portfolio, this underscores the importance of focusing on "capital-efficient" firms, as the macro-drag from misallocation will likely persist even if nominal rates decline.
Synthesis: The overarching theme is a transition from "hidden" risks to "realized" costs, specifically regarding regulatory arbitrage in banking and the lagging inflationary impact of tariffs. We should brace for a period of heightened volatility in the small-cap space and a more hawkish-than-expected Fed response to tariff-driven inflation.
The paper examines how bank holding companies utilize internal capital markets to meet Basel III requirements by shifting equity from nonbank subsidiaries to bank subsidiaries. This internal reallocation may mask systemic fragility by avoiding the necessity of raising new external capital.
This post concludes a three-part series on how bank regulation interacts with the organizational structure of banking firms. The first post documented the equity-rich nonbank subsidiaries inside bank holding companies (BHCs); the second post showed that BHCs met Basel III by reallocating capital internally, moving equity from nonbank affiliates to bank subsidiaries rather than raising new external capital. Here we ask what that reallocation meant for financial stability. The series draws on the authors' recent Staff Report, "Regulatory Arbitrage Within the Firm."
The paper examines how Basel III regulations influence the distribution of capital within bank holding companies. It finds that nonbank subsidiaries act as equity reservoirs, leading to a divergence between bank-level and consolidated capital.
This post is the second in a three-part series on how bank regulation interacts with the organizational structure of banking firms. The first post documented that nonbank subsidiaries inside bank holding companies (BHCs) are large, equity-rich "reservoirs," and that bank-level capital diverged sharply from consolidated capital after Basel III took effect in 2015. This post asks why, and traces the answer through the internal plumbing of the holding company. The series draws on the authors' recent Staff Report, "Regulatory Arbitrage Within the Firm."
This research explores the phenomenon of regulatory arbitrage occurring within the organizational structures of bank holding companies. It analyzes how firms shift assets and capital to optimize regulatory treatment.
This post is the first in a three-part series on how bank regulation interacts with the organizational structure of banking firms. The series draws on the authors' recent Staff Report, "Regulatory Arbitrage Within the Firm."
This analysis utilizes the Small Business Credit Survey to evaluate the impact of tariffs on small businesses across the U.S. and the Second District. It aims to fill a data gap regarding how trade barriers affect small-scale enterprise operations and credit needs.
How has the recent implementation of tariffs affected small businesses? Due to lack of data, little is known about this issue. In this Liberty Street Economics post, we use data from the 2025 edition of the Small Business Credit Survey (SBCS) to explore this question for businesses nationally and in the Second District (defined, for the purpose of this study, as New York, New Jersey, and Connecticut). We find that the majority of national firms in the goods and retail sectors reported experiencing financial challenges due to tariffs in 2025, with even larger shares of regional firms doing so.
The paper examines how businesses respond to sweeping U.S. trade policy changes and new tariffs. It analyzes the trade-off between absorbing increased costs through profit margins versus passing them on to consumers via higher prices.
The past year brought dramatic changes to U.S. trade policy, including sweeping new tariffs, as well as a Supreme Court decision that further reshaped the tariff landscape. Many businesses saw their costs increase significantly and faced complex decisions about whether to absorb the tariffs through lower profit margins, raise their prices to recover the higher costs, or some combination of the two. Last year, we found that most businesses had passed on at least some of these higher costs to their customers through higher prices. Now, over a year later, have businesses finished adjusting prices
The paper examines the causal role of bank runs in financial crises, debating whether they act as primary catalysts or symptoms of systemic instability. It analyzes a large dataset of runs to determine how small shocks escalate into widespread failures.
Runs on financial institutions are one of the salient markers of financial crises. But the role of runs in crises is a topic of longstanding debate. Runs can be seen as the key turning point, whereby even small shocks can generate severe crises with widespread bank failures. Another view is that runs are mainly a symptom of deeper rot in the financial system, exacerbating crises rather than being their primary cause. Understanding this debate has first order implications for how to think about financial crises and the appropriate policy responses. In this post, we use a new database of more th
This research utilizes large language models to synthesize a comprehensive historical database of U.S. bank runs from digitized newspaper archives. The study aims to overcome data limitations to better understand the empirical patterns of banking panics.
Banking crises are commonly associated with bank runs and banking panics, yet our empirical understanding of bank runs is constrained by a lack of bank-level data. In a new paper, we use large language models (LLMs) to extract information on bank runs from millions of digitized historical newspaper pages, creating the most comprehensive database of bank runs in U.S. history. Every bank run episode that we identify is documented on a companion website where users can browse and examine individual episodes, and read the original newspaper articles. In this post, we describe how we built this dat
The paper analyzes the 'overnight drift' in U.S. equity futures, noting a historical pattern of persistent returns during the European market opening window. Recent data suggests this anomaly has largely faded, indicating increased market efficiency or shifting trading dynamics.
In a 2021 Liberty Street Economics post, we documented the “overnight drift”—a large, persistent return to holding U.S. equity futures in the narrow window between 2:00 and 3:00 a.m. Eastern time, when European equity markets open. Five additional years of data later, that pattern appears to have faded: the 2:00–3:00 window that previously generated roughly 3.7 percent per annum has averaged close to zero since 2021. In this post, we revisit the overnight drift in light of the post-publication sample and use our inventory-risk framework to ask which of three observable channels—the dispersion
The study investigates the 'K-shaped' recovery hypothesis by analyzing economic data over the last thirty years. It finds that recovery patterns following recessions differ significantly from standard economic periods.
The evidence during recoveries from recessions differs from other periods.
This research explores the relationship between homeowner equity and the maintenance of flood insurance. It suggests that mortgage debt levels may act as a substitute for disaster insurance in the event of a loss.
The amount of equity homeowners have may influence whether they maintain flood insurance.
The paper examines the aggregate reliance of the U.S. economy on fossil fuels relative to gross output. It finds that fossil fuel usage has remained relatively constant over time.
The aggregate use of fossil fuels in gross output has remained relatively constant for two reasons.
The paper examines how geopolitical alignment influences the implementation of product-level export controls. It finds that trade restrictions are strategically targeted based on geopolitical distance to mitigate security risks.
This research analyzes how variations in the cost of capital lead to resource misallocation across the U.S. economy. It argues that these inefficiencies hinder overall productivity and aggregate economic output.
This paper examines the historical evolution and institutional importance of the Federal Reserve's operational independence. It argues that autonomy from political influence is critical for maintaining long-term price stability and effective monetary management.
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