Category Archives: Commentary

Rumsfeldian Journalism

By James Kwak

I still have Nate Silver in my Twitter feed, and I used to be a pretty avid basketball fan, so when I saw this I had to click through:

In the article, Benjamin Morris tries to analyze how “bad”* the Detroit Pistons of the late 1980s and early 1990s (Bill Laimbeer, Rick Mahorn, Dennis Rodman, etc.) were, with full 538 gusto: “That seems like just the kind of thing a data-driven operation might want to quantify.” But the attempt falls short in some telling ways.

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Defending Kickbacks

By James Kwak

The Wall Street Journal reports that the SEC will soon decide (well, sometime this year) whether brokers should be subject to a fiduciary standard in their dealings with clients, as registered financial advisers are today. At present, brokers only need to show that investments they recognize are “suitable” for their clients—roughly speaking, that they are in an appropriate asset class.

Not surprisingly, the brokerage industry is up in arms. They want to be able to push clients into the products for which they receive the highest commissions—a practice that (they say) could be more difficult under a fiduciary standard. According to one lobbyist,

a universal fiduciary standard could end up hurting many investors. Lower- and middle-income investors often turn to brokers who are compensated through product commissions, he says, because such clients are less attractive to financial advisers who are compensated based on a percentage of assets under management. Higher costs could prompt some brokers to drop commission-based accounts in favor of more-lucrative accounts that charge a percentage of assets under management, leaving many lower- and middle-income investors without anyone to turn to for investment advice.”

(That’s a paraphrase by the Journal writer, not a direct quotation.)

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What Might Have Been . . .

By James Kwak

I was reading the plea deal in the SAC case, which was approved by the judge yesterday, and then I started reading the criminal indictment filed by the U.S. Attorney’s Office. What I noticed was how relatively simple it was for the prosecutors to convict SAC Capital for the insider trading committed by its employees. In short, because the firm enabled and benefited from the employees’ crimes, the firm was itself criminally liable.

Looking back at the enormous amount of effort the Southern District has put into Preet Bharara’s crusade against insider trading, you have to wonder what they might have accomplished had they instead targeted, say, fraud committed by Wall Street banks that contributed to the financial crisis. That’s the topic of my new column in The Atlantic. One of the frustrations of post-crisis legal proceedings is that it’s so hard to show that any senior executives themselves committed fraud, since they can usually plead some combination of ignorance and incompetence instead. Failing that, though, the government could have put more resources into flipping lower-level employees and then filing criminal indictments against their banks. Yesterday Bharara claimed, “when institutions flout the law in such a colossal way, they will pay a heavy price.” But only if the Department of Justice chooses to go after them.

The Absurdity of Fifth Third

By James Kwak

No, I’m not talking about the fact that a major bank is named Fifth Third Bank. (As a friend said, why would you trust your money to a bank that seems not to understand fractions?) I’m talking about Fifth Third Bancorp. v. Dudenhoeffer, which was heard by the Supreme Court last week.

The plaintiffs in Fifth Third were former employees who were participants in the company’s defined contribution retirement plan. One of the plan’s investment options was company stock, and the employees put some of their money in company stock. (Most important lesson here: don’t invest a significant portion of your retirement assets in your company’s stock. Remember Enron? Anyway, back to our story.) As you probably guessed, Fifth Third’s stock price fell by 74% from 2007 to 2009—this is a bank, you know—so the plaintiffs lost money in their retirement accounts.

The claim (I’m looking at the 6th Circuit opinion)  is that the people running the retirement plan knew or should have known that Fifth Third stock was overvalued in 2007, and they breached their fiduciary duty to plan participants by continuing to offer company stock as an investment option and by failing to sell the company stock that was owned by the plan. The suit was dismissed in the district court for failure to state a claim, so on review the courts are supposed to accept all the plaintiffs’ allegations as correct.

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Disability Insurance Basics

By James Kwak

A while back I wrote a post critical of a Planet Money/This American Life episode on disability insurance. Among other things, I thought that the episode made too much of the fact that the number of people on federal disability insurance (SSDI or SSI) has gone up since the financial crisis.

The book I’m currently reading with my daughter at family reading time (she just finished a fictional book about a Polish immigrant girl in a mining community in the late nineteenth century) is Social Insurance: America’s Neglected Heritage and Contested Future, by Theodore Marmor, Jerry Mashaw, and John Pakutka. It’s a pretty good overview of the programs that are typically thought of (at least by the left and center-left) as social insurance in this country. Here’s what they say about recent trends in disability insurance (pp. 166–67):

“It has long been understood by those who study disability insurance that during times of economic distress, the incidence of claimed disability increases. Impairments that might have been overcome during times of economic growth and high rates of employment become the basis for claims of disability. . . . As a recession drags on and jobs are not plentiful, many no doubt make the choice to see if a musculoskeletal malady or a mood disorder qualifies them for disability insurance benefits.”

In the longer term—meaning before the financial crisis—disability rates have been creeping upward. The main reasons are: (1) an aging population; (2) the slow increase in the full retirement age for Social Security, which keeps people on SSDI (as opposed to OASI) longer; and (3) the increasing frequency of musculoskeletal and mood disorder claims (e.g., depression). These are all completely normal things, unless you want to go back to the bad old days when mental illnesses like depression were not considered on pair with physical illnesses. At the margin, there is certainly fraud in the system, but in fact it’s quite hard to get disability benefits, and the standards aren’t getting any more lenient.

Sometimes the real story isn’t all that mysterious.

The Too Big To Fail Subsidy Debate Is Over

By Simon Johnson

No doubt there is still a lot of shouting to come, but this week a team at the International Monetary Fund completely nailed the issue of whether large global banks receive an implicit subsidy courtesy of the American government.   Is there a subsidy, is it large, and how much damage could it end up causing to the broader economy?

The answers, in order, are: yes, there is an implicit subsidy that lowers the funding costs for very large banks; the subsidy is big, with costs of borrowing for these banks lowered by as much as 100 basis points, i.e., 1 percentage point; and yet this large scale of implicit support is small relative to the macroeconomic damage that is likely to be caused by the high leverage and incautious risk-taking that the subsidy encourages.

If anything the IMF’s work provides a conservative (i.e., low) set of estimates.

Still, as I explain in my NYT.com Economix column, I’m a big fan of this work because the Fund’s report is very good on how to handle and reconcile the main alternative methodologies for getting at the issue.

The Fund offers an entirely reasonable approach that sets a very high quality bar. The Government Accountability Office (G.A.O.) is expected to produce a report on TBTF subsidies in the summer; their work now needs to be at least as careful and as comprehensive as that of the IMF. The same applies to the Federal Reserve and anyone in the private sector who attempts to dispute these numbers.

More Pseudo-Contrarianism

By James Kwak

I accidentally glanced at the link to David Brooks’s recent column and—oh my god, is it stupid. You may want to stop reading right here to avoid being exposed to it.

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Citigroup CEO Named To “Key Administration Post”

By Simon Johnson

Just a few short days ago, it looked like Citigroup was on the ropes. The company’s proposal for redistributing capital back to shareholders was rejected by the Board of Governors of the Federal Reserve System. Given the global bank’s repeated fiascos – including most recently the theft of around $400 million from its Mexican unit – it is hardly surprising that the Fed has said “no” (and for the second time in three years).

The idea that Citigroup might now or soon have a viable “living will” now seems preposterous. If top management cannot run sensible financial projections (that’s the Fed’s view; see p.7 of the full report), what is the chance that they can lay out a plausible plan to explain how the company, operating in more than 100 countries worldwide, could be wound down through bankruptcy – without any financial assistance from the government? According to the Dodd-Frank financial reform law, failure to submit a viable living will should result in remedial action by the authorities.

Such action has now been taken: CEO Michael Corbat has been named to a top White House job, with responsibility for helping to develop “financial capability for young Americans.” Continue reading

Perhaps The Most Boring Important Topic In Economics

By Simon Johnson

International economic policy making is a contender for the title of “most boring important topic” in economics.  And within the field there is nothing quite as dull as the International Monetary Fund (IMF).  Try getting an article about the Fund on the front page of any newspaper.

And even for aficionados of the Fund, the issues associated with reforming its “quota” and “voting rights” seem arcane – and are fully understood by few.

Dullness in this context is not an accident – it’s a protective wrapping against political interference, particularly by the US Congress.

Now, however, the IMF needs a change in its ownership structure, and the sole remaining holdup is Congress.

The Obama administration let this issue slide for a long while, and then attempted to link it with financial aid being extended to Ukraine.  That attempt failed last week.

In a column for Project Syndicate, I discuss why this matters and what comes next.  Try not to fall asleep.

The Chinese Boom-Bust Cycle

By Simon Johnson

Should we fear some sort of financial crash in China, along the lines of what we saw in 2008 in the US or after 2010 in the euro area?

Given the rate of growth in credit and the expansion of the so-called shadow banking sector over the past five years in China, some sort of financial bust seems hard to avoid.

But this need not be the hard landing seen in more developed countries – and the impact on the world economy will likely be much more moderate.  At the same time, however, bigger problems await in the not-too-distant future.

Peter Boone and I review the details in a column for NYT.com’s Economix blog.

Stress Tests, Lending, and Capital Requirements

By James Kwak

Despite the much-publicized black eye to Citigroup’s management, the bottom line of the Federal Reserve’s stress tests is that every other large U.S. bank will be allowed to pay out more cash to its shareholders, either as increased dividends or stock buybacks. And pay out more cash they will: at least $22 billion in increased dividends (that includes all the banks subject to stress tests), plus increased buyback plans.

Those cash payouts come straight out of the banks’ capital, since they reduce assets without reducing liabilities. Alternatively, the banks could have chosen to keep the cash and increase their balance sheets—that is, by lending more to companies and households. The fact that they choose to distribute the cash to shareholders indicates that they cannot find additional, profitable lending opportunities.

This puts the lie to the banks’ mantra that capital requirements will constrain lending and therefore reduce growth (made most famously in the Institute of International Finance’s amateurish report claiming that increased regulation would make the world’s advanced economies 3 percent smaller). Capital isn’t the constraint on bank lending: it’s their willingness to lend.

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Stopping Russia

By Simon Johnson

The rhetoric of confrontation with Russia seems to be escalating, including with the remarkable suggestion – from Mike Rogers, the chairman of the House Intelligence Committee – that the US provide “small arms and radio equipment” to Ukraine.

Encouragement for a military confrontation is not what Ukraine needs.  As Peter Boone and I have argued in a pair of recent columns for the NYT.com’s Economix blog, Ukraine needs economic reform (with a massive reduction in corruption as the top priority).   This reform requires, above all, a massive and immediate reduction in – or elimination of – corruption.

Throwing a lot of external financial assistance at Ukraine’s government, for example with a very large loan from the International Monetary Fund, is unlikely to prove helpful.  Based on recent prior experience, such lending may even prove counterproductive.

And this seems to be exactly the path that our foreign policy elite has placed us on.

Skew

By James Kwak

There is a common phenomenon in legal disputes over the value of something, be it a company, a piece of land, or a person’s expected lifetime earnings. Each side hires an “expert” who produces an estimate based on some kind of model. And miraculously, every single time, the expert for the party that wants a higher number comes up with a high number, while the expert for the party that wants a lower number comes up with a low number. No one is surprised by this.

Yesterday, the Federal Reserve posted the results of the latest periodic bank stress tests mandated by the Dodd-Frank Act. For these tests, the Fed comes up with various scenarios of how things could go badly in the economy, and the goal is to see how banks’ income statements and balance sheets would respond. The key metrics are the banks’ capital ratios; the goal is to identify if, in bad states of the world, the banks would still remain solvent. If not, the banks won’t be allowed to do things that reduce their capital ratios today, like paying dividends or buying back stock.

For the most part, the results look pretty good: capital levels even under the severely adverse scenario should remain above the levels reached during the 2008–2009 crisis. (Of course, there are several huge caveats here. You have to believe: first, that the scenarios are sufficiently pessimistic; second, that the banks’ current financials are accurately represented; third, that the model is sensible; and fourth, that the capital levels set by current law are high enough.)

But there’s something else going on here. As part of the stress testing routine, each bank is supposed to do its own simulation of how it would respond to the scenarios specified by the Fed, using its own internal model. And—surprise, surprise!—the banks virtually uniformly predict that they will do better than the Fed.

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Whiskey Costs Money

By James Kwak

A few days ago I wrote a post that began with New York Fed President William Dudley talking tough about banks: “There is evidence of deep-seated cultural and ethical failures at many large financial institutions.” The thrust of that post was that I’m not very encouraged when regulators talk about culture and the “trust issue” but don’t indicate how they are going to actually affect industry behavior.

As they say, talk is cheap, whiskey costs money. What’s more important than what regulators say is what they do—and don’t talk about. Peter Eavis (who wrote the earlier story about bank regulators that my previous post was responding to) wrote a new article detailing how that same William Dudley has delayed the finalization of the supplementary leverage ratio: the backup capital standard that requires banks to maintain capital based on their total assets, not using risk weighting.

Dudley has said, “I do not feel that I in any way hold any allegiance or loyalty to the financial industry whatsoever.” That may be true; he certainly made enough at Goldman that he has no real financial incentive to continue to make nice with Wall Street.* Yet at the same time he appears to be parroting concerns raised by some of the big banks, raising a concern about the leverage rule that Felix Salmon calls “very silly” and that, according to Eavis, the Federal Reserve mother ship in Washington didn’t consider significant.

In the grand scheme of banks and their allies weakening and slowing down new regulation, this is probably not a particularly momentous battle. But it does put things in perspective.

* Of course, we know that among some people (many of whom live in New York and work in finance), no amount of money is ever enough.

You Don’t Say

By James Kwak

Last week Peter Eavis of DealBook highlighted a statement made last year by New York Fed President William Dudley (formerly of Goldman Sachs, then a top lieutenant to Tim Geithner): “There is evidence of deep-seated cultural and ethical failures at many large financial institutions.” There was a point, say in 2008, when many people probably thought that our largest banks were just guilty of shoddy risk management, dubious sales practices, and excessive risk-taking. Since then, we’ve had to add price fixing, money laundering, bribery,  and systematic fraud on the judicial system, among other things. 

Eavis also tried to make something positive out of a couple of other recent comments. Dudley said, “I think that trust issue is of their own doing—they have done it to themselves,” while OCC head Thomas Curry said, “It is not going to work if we approach it from a lawyerly standpoint. It is more like a priest-penitent relationship.”

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