By James Kwak

One of the criticism’s of Michael Lewis’s book is that he gets his moral wrong. High-frequency trading doesn’t hurt the little guy, as Lewis claims; instead, it hurts the big guy. The explanation is this: people sitting at their desks buying 100 shares of Apple are getting the current ask, so mainly they care about volume and tight bid-ask spreads. Institutional investors, buy contrast, want to buy and sell huge blocks of shares, and they don’t want the price to move in the process; they are the ones being front-run by the HFTs. Felix Salmon pointed this out, and it’s the subject of an op-ed by Philip Delves Broughton today.

What this leaves out is the question of who ends up being harmed. To figure that out, you have to ask whose money we’re talking about when we say “institutional investor.” If it’s SAC Capital, meaning Steven Cohen’s money, then who cares? But most ordinary people invest—if they are lucky enough to have money to invest—through mutual funds (401(k) plans, for example, are largely invested in mutual funds), and those funds are among the “institutional investors” losing money to HFTs. Another big chunk of institutional money belongs to pension funds. In this case, if the pension fund does poorly, the money may come out of its corporate sponsor in the form of increased contributions—or it may come out of beneficiaries and taxpayers in the form of a bankrupt plan shifting its obligations to the PBGC. Then there are insurance companies: in that case, losses from trading affect shareholders, but if they are systemic across the industry they end up as higher premiums for consumers.

This is not to say that the institutional investors are warm and cuddly and are just passive victims in all of this. I’ve spilled enough ink inveighing against active asset managers, and Salmon points out that the buy side bears its share of blame for being careless with other people’s money. At the end of the day, if HFT harms other people in the markets, it’s just a fraternal spat among capital, and doesn’t affect the fundamental divide in the post-Piketty world. Until a poorly-tested algorithm goes berserk and freezes the financial system, that is.

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

The Desperation of the Vanishing Middle Class

By James Kwak

I recently finished reading Pound Foolish, by Helaine Olen, which I discussed earlier (while one-third of the way through). The book is a condemnation of just almost every form of personal financial advice out there, from the personal finance gurus (Suze Orman, Dave Ramsey) to the variable annuity salespeople to the peddlers of real estate get-rich-quick schemes to Sesame Street‘s corporate-sponsored financial education programs. (Of them all, Jane Bryant Quinn is one of the few who generally come off as more good than evil.)

A lot of what’s going on is just semi-sleazy entrepreneurs trying to make a buck, taking “advice” that is equal parts routine, wrong, and contradictory and packaging it into attractive-looking books, TV shows, and in-person events. A lot of the rest is marketing by the real financial industry, which either (a) wants to make a show of promoting financial education so people will think they are good or (b) wants to teach people that they need their products. (You pick.)

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’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.

Continue reading

A Book That Needed To Be Written

By James Kwak

I have previously written about (here, for example) what I call economism, or excessive belief in the little bit that you remember from Economics 101. The problem is twofold. First, Economics 101 usually paints a highly stylized, unrealistic view of the world in which free markets always produce optimal outcomes. Second, most people in the world who have taken any economics have only taken first-year economics, and so they never learned that, from a practical perspective, just about everything in Economics 101 is wrong. (Complete information? Rational actors? Perfectly competitive markets?) This produces a nation of people like Paul Ryan, who repeats reflexively that free market solutions are always good, journalists who repeat what Paul Ryan says, and ordinary people who nod their heads in agreement.

The problem is not the economics profession per se. These days, to make your mark as an economist, it helps to be arguing (or, better yet, proving) that the free market caricature of Economics 101 is wrong. The problem is the way it is taught to first-year students, which pretty much assumes that Joseph Stiglitz, Daniel Kahnemann, Elinor Ostrom, and many others had never existed.

What we need, I have often thought, is a companion book for students in Economics 101, one that points out the problems with the standard material that is covered in the textbook. For a while I was thinking of writing such a book, but I decided against it for a number of reasons, one of them being that I am not actually an economist. Fortunately, John Komlos, who really is an economist, has written a book along these lines, titled What Every Economics Student Needs to Know and Doesn’t Get in the Usual Principles Text.

Continue reading