Archive for April 2011
The FDIC’s Resolution Problem
By Simon Johnson. Links to the articles mentioned below are available here: http://economix.blogs.nytimes.com/2011/04/28/the-problem-with-the-f-d-i-c-s-powers/
Under the Dodd-Frank financial reform legislation (Title II of that Act), the Federal Deposit Insurance Corporation (FDIC) is granted expanded powers to intervene and manage the closure of any failing bank or other financial institution. There are two strongly-held views of this legal authority: it substantially solves the problem of how to handle failing megabanks and therefore serves as an effective constraint on their future behavior; or it is largely irrelevant.
Both views are expressed by well-informed people at the top of regulatory structures on both sides of the Atlantic (at least in private conversations). Which is right? In terms of legal process, the resolution authority could make a difference. But as a matter of practical politics and actual business practices, it means very little for our biggest financial institutions. Read the rest of this entry »
Bond Market Blackmail
By James Kwak
Like probably most people, I have not been following the saga of Iceland and its banks’ foreign depositors, so I was grateful for Planet Money’s podcast last week on the topic. The background, as I understand it, is something like this:
- Iceland’s banks offered high-rate savings accounts to depositors in other countries, notably the United Kingdom and the Netherlands. These accounts did not have an explicit government guarantee.
- In 2008, the global financial system nearly collapsed, Iceland’s banks failed, and depositors got more or less wiped out.
- Iceland, unlike Ireland, did not guarantee its banks’ liabilities. It did, however, choose to bail out domestic depositors in those banks — but not foreign depositors.
- The U.K. and the Netherlands both chose to bail out their citizens who had deposited money in Iceland’s banks.
- The U.K. and the Netherlands then tried to get the Icelandic government to pay them back. They negotiated a settlement, but that was rejected by a popular referendum in Iceland. Then they negotiated another settlement (which would have cost Iceland about $6,000 per person), but that was also rejected.
Now, there is a legal question about whether or not Iceland has an obligation to bail out foreign depositors in its banks. Remember, there was no explicit government guarantee. The question is whether bailing out domestic but not foreign depositors is illegal discrimination under international law.* Apparently that’s a close question, but it’s not relevant for my purposes.
The economic question, as the podcast framed it, is whether paying off the U.K. and Dutch governments will help Iceland attract foreign investment in the future. They had a bond investor from Vanguard — ordinarily just about my favorite financial institution — saying that a vote against the settlement would make investors less likely to lend money to the Icelandic economy in the future.
Now, this may be true (although I doubt it). But think about what this is really saying.
$3 Billion Banks
By James Kwak
Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.
“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.
“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”
So what does Jon Macey think of big banks?
Allocative Efficiency for Beginners
By James Kwak
I was catching up on some old Planet Money episodes and caught Allen Sanderson of the University of Chicago talking about how to allocate scarce resources. The first day of introductory economics, he says, there are always more students than seats. Say there are forty extra people, and he can only accept ten more into the class. He asks the class: how should the ten slots be allocated? You can easily guess the typical suggestions: by seniority, because seniors won’t be able to take the class later; by merit (e.g., GPA), because better students will contribute more to the class and get more out of it; to the first ten people outside his office at 8 am the next day, since that is a proxy for desire to get in; randomly, since that’s fair; and so on. Someone also invariably suggests auctioning off the slots.
This, Sanderson says, illustrates the core tradeoff of economics: fairness and efficiency. If you auction off the slots, they will go to the people to whom they are worth the most, which is best for the economy as a whole.* If we assume that taking the class will increase your lifetime productivity and therefore your lifetime earnings by some amount, then you should be willing to pay up to the present value of that increase in order to get into the class. An auction therefore ensures that the slots will go to the people whose productivity will go up the most. But of course, this isn’t necessarily fair, especially when you consider that the people who will get the most out of a marginal chunk of education are often the people who have the most already.
Blog Archive
By James Kwak
Last month a reader pointed out that many of the links in the blog archive were broken. The problem is that Feedbooks, the service I was using, no longer allows you to transform RSS feeds into PDFs. I fixed the links up through April 2010, but the problem is that I no longer have an elegant way of creating new PDF archives. Basically I need something that will allow me to type in an RSS feed and will generate a PDF from that feed.
For example, this is the feed for May 2010, in forward chronological order. When I type that feed URL into Chrome, I get raw XML. When I type it into Firefox, it gives me truncated versions of each post. When I type it into Safari, it gives me full posts, but in its infinite wisdom, it sorts them in reverse chronological order; the sort by date feature only allows reverse chronological. When I type it into Google Reader, I get full posts in the right order, but I lose the post dates (they are replaced by the current date). Bloglines is like Safari — it insists on reverse chronological. RSS 2 PDF only gives me post titles. FeedShow displays nothing.
If I could get any of these to work in any browser, I could just convert that to a PDF and be done. Any suggestions?
Update: To be clear, saving a web page (or anything) as a PDF is not the problem. It’s trivial on a Mac (and not that hard on a PC, either). The problem is getting the full text of all the posts in the feed, in the proper order, with the proper dates, on one web page.
Is S&P’s Deficit Warning On Target?
By Simon Johnson
On Monday Standard & Poor’s announced that its credit rating for the United States was “affirmed” at AAA (the highest level possible), but that it was revising the outlook for this rating to “negative” – in this context specifically meaning “that we could lower our long-term rating on the U.S. within two years” (p.5 of the report). This news temporarily roiled equity markets around the world, although the bond markets largely shrugged it off.
While S&P’s statement generated considerable media attention, the economics behind their thinking is highly questionable – although, given the random nature of American politics, even this intervention may still end up having a constructive impact on the thinking of both the right and the left.
It is commendable that S&P now wants to talk about the U.S. fiscal deficit – one wonders where they were, for example, during the debate about extending the Bush-era tax cuts at the end of last year. Read the rest of this entry »
“Fiscal Conservatives” Dodge $10 Trillion Debt
By Simon Johnson. This post comprises the opening paragraphs of my column today on Bloomberg; the rest is available here: http://www.bloomberg.com/news/2011-04-19/fiscal-conservatives-dodge-10-trillion-debt-simon-johnson.html
Washington is filled with self- congratulation this week, with Republicans claiming that they have opened serious discussion of the U.S. budget deficit and President Barack Obama’s proponents arguing that his counterblast last Wednesday will win the day.
The reality is that neither side has come to grips with the most basic of our harsh fiscal realities.
Start with the facts as provided by the nonpartisan Congressional Budget Office. Compare the CBO’s budget forecast for January 2008, before the outbreak of serious financial crisis in the fall of that year, with its latest version from January 2011. The relevant line is “debt held by the public at the end of the year,” meaning net federal government debt held by the private sector, which excludes government agency holdings of government debt.
In early 2008, the CBO projected that debt as a percent of gross domestic product would fall from 36.8 percent to 22.6 percent at the end of 2018. In contrast, the latest CBO forecast has debt soaring to 75.3 percent of GDP in 2018.
What caused this stunning reversal, which in dollar terms works out to a $10 trillion swing for end-year 2018 debt, from $5.1 trillion to $15.8 trillion?
To read the rest of this post, click here.
Could Goldman Sachs Fail?
By Simon Johnson. This link to MIT Sloan’s website provides a partial transcript and video covering the points made below.
If Goldman Sachs were to hit a hypothetical financial rock, would they be allowed to fail – to go bankrupt as did Lehman – or would they and their creditors be bailed out?
I asked this question on Sunday to four leading experts (Erik Berglof, Claudio Borio, Garry Schinasi, and Andrew Sheng) from various parts of the official sector at the Institute for New Economic Thinking (INET) Conference in Bretton Woods – and to a room full of people who are close to policy thinking both in the United States and in Europe. In both the public interactions (for which you can review video here) and private conversations later, my interpretation of what was said and not said was unambiguous: Goldman Sachs would be bailed out (again).
This is very bad news – although admittedly not at all surprising. Read the rest of this entry »
My Medicare Deficit Solution
By James Kwak
David Brooks, perhaps realizing that it was a bad idea to swallow a politician’s PR bullet points whole, is now backpedaling. The Ryan Plan, which he originally hailed as “the most comprehensive and most courageous budget reform proposal any of us have seen in our lifetimes,” now has the principal virtue of existing: “Because he had the courage to take the initiative, Paul Ryan’s budget plan will be the starting point for future discussions.”
As I’ve discussed before, the Ryan Plan is just one bad idea dressed up with the false precision of lots of numbers: changing Medicare from a health insurance program to a cash redistribution program that gives up on managing health care costs. Here’s the key chart from the CBO report:
Who Wants a Voucher?
By James Kwak
In yesterday’s post, I compared two ways of solving the long-term Medicare deficit: (a) increasing payroll taxes and keeping Medicare’s current structure or (b) keeping payroll taxes where they are and converting Medicare into a voucher program. As a person who will need health insurance in retirement, I prefer (a), but others could differ.
Today I want to ask a different question. Let’s say Medicare does become a voucher program along the lines proposed by Paul Ryan. So workers pay 2.9 percent of their wages and in retirement they get a voucher. According to the CBO, if you turn 65 in 2030, that voucher will pay for 32 percent of your total health care costs, including private insurance premiums and out-of-pocket expenses (see pp. 22-23). Would you rather have that deal or nothing at all?
The Vickers Commission Report On Banking
By Simon Johnson
Will the Vickers Commission report on UK banking – with a preliminary report released today – have a major positive impact? Not likely in our assessment – see today’s Daily Telegraph.
The fight to reform the banking system in the US and more broadly is largely over – and the bankers won. A number of sensible ideas were put forward – including on creating a resolution authority, reducing the scale and scope of big banks, and significantly increasing capital requirements. As reviewed by Peter Boone and me in this morning’s Financial Times, all of these initiatives have essentially failed.
Medicare for Beginners
By James Kwak
This isn’t a post explaining how Medicare works in detail. It’s a post about why Medicare matters to you.
The basic “problem” with Medicare is that its liabilities are projected to grow faster than its revenues indefinitely because health care costs are growing faster than GDP (and Medicare’s revenues are a function of wages).* The “solution” proposed by Paul Ryan is to convert Medicare from an insurance program, which pays most of your health care expenses, to a voucher program, which gives you a certain amount of money that you can try to use to buy health insurance. I’ve described the main problems with this approach already: it transforms a large future government deficit into an even larger future household deficit, and on top of that it shifts risks from the government to individual households. Today I want to look at this from a different angle.
Taxes and Spending for Beginners
By James Kwak
Over the long term, we are projected to have large and growing federal budget deficits. Assuming that is a problem, which most people do, there seem to be two ways to solve this problem: raising taxes and cutting spending. Today, the political class seems united around the idea that spending cuts are the solution, not tax increases. That’s a given for Republicans; Paul Ryan even proposes to reduce the deficit by cutting taxes. But as Ezra Klein points out, President Obama and Harry Reid are falling over themselves praising (and even seeming to claim credit for) the spending cuts in Thursday night’s deal. And let’s not forget the bipartisan, $900 billion tax cut passed and signed in December.
The problem here isn’t simply the assumption that we can’t raise taxes. The underlying problem is the belief that “tax increases” and “spending cuts” are two distinct categories to begin with. In many cases, tax increases and spending cuts are equivalent — except for the crucial issue of who gets hurt by them.*
Big Banks Have A Powerful New Opponent
By Simon Johnson
As a lobby group, the largest U.S. banks have been dominant throughout the latest boom-bust-bailout cycle – capturing the hearts and minds of the Bush and Obama administrations, as well as the support of most elected representatives on Capitol Hill. Their reign, however, is finally being seriously challenged by another potentially powerful group – an alliance of retailers, big and small – now running TV ads (http://youtu.be/9IUt-lY-XgM, by Americans for Job Security), web content (http://www.youtube.com/watch?v=DiKoFzS_lXs, by American Family Voices), and this very effective powerful radio spot directly attacking “too big to fail” banks: http://www.savejobs.org/audio18.html.
The immediate issue is the so-called Durbin Amendment – a requirement in the Dodd-Frank financial reform legislation that would lower the interchange fees that banks collect when anyone buys anything with a debit card. Retailers pay the fees but these are then reflected in the prices faced by consumers.
The US has very high debit card “swipe” fees – 44 cents on average but up to 98 cents for some kinds of cards. These fees are per transaction – representing a significant percent of many purchases but posing a particular problem for smaller merchants. This is estimated to be around $16-17 billion in annual revenue.
Other countries, such as Australia and members of the European Union, have already taken action to reduce interchange fees – because the cost of such transactions is actually quite low (think about it: the “interchange fee” for checks, which also draw directly on bank deposits, is exactly zero). The United States severely lags behind comparable countries in terms of how consumers are treated by banks in this regard. Read the rest of this entry »
Moment of Blather
By James Kwak
David Brooks’s commentary on Paul Ryan’s “budget proposal” is entitled “Moment of Truth.” Brooks falls over himself gushing about his new man-crush, calling it “the most comprehensive and most courageous budget reform proposal any of us have seen in our lifetimes.” “Ryan is expected to leap into the vacuum left by the president’s passivity,” he continues.
Gag me.
