Month: June 2009

The Financial Regulation Debate in One Post

Tim Geithner will be testifying before both Senate and House committees next Thursday on the administration’s proposal for financial regulation. In the meantime, there will be a lot of talk about financial regulation.

The Wall Street Journal (subscription required) and Washington Post (subscription not required) have been reporting on how the administration’s plans have been “pared back.” Those articles mainly dwell on the likelihood that the administration will not try to abolish and consolidate agencies as had once been thought possible (although OTS and OCC may be merged). This is interesting, given that Larry Summers just said that eliminating regulatory arbitrage was one of his key principles.

Tyler Cowen has some intelligent thoughts on why consolidation may not be such a great idea. My feeling is that consolidation could be good insofar as the current situation is clearly bad. I agree with Felix Salmon:

The current regulators have clearly failed at their jobs, there’s no reason for entities like the OCC and the OTS to continue to exist, and it’s worth remembering at all times that the number of large American financial-services companies with intelligent and sophisticated and effective regulation is, currently, zero.

Continue reading “The Financial Regulation Debate in One Post” →

Snowball: Strategies For Banking Reform

I was on a Capitol Hill panel yesterday morning, organized by the National Community Reinvestment Coalition, with Jim Carr and Mike Lux; Nancy Cleeland was the moderator. We had a wide-ranging discussion about the origins of our current economic crisis (the banks, their regulators, their lack of regulation), progress to date with financial sector reform (not much), and what should be the legislative agenda (a long list, ranging from protecting individuals to better safeguarding the system; if you can get any sensible measure past the lobbies, take it).

I was particularly struck by one point made by Mike Lux. Sometimes it seems the administration talks in terms of having limited political capital and of needing to decide where to spend it – perhaps, for example, it has all been stored up to address health care. Mike’s model is somewhat different – once you defeat one powerful industrial lobby, it becomes easier to defeat others; success can snowball. Drawing on the experience of FDR, in particular, Mike stressed that early success (e.g., initial recovery measures that were opposed by industry) laid the political foundations and generated the kind of public support necessary for further achievement (e.g., the introduction of social security).

What does that mean in today’s context? Continue reading “Snowball: Strategies For Banking Reform” →

More on Executive Compensation

I was surprised at the number of commenters on yesterday’s post who thought that executive compensation is a red herring or a political talking point or “populist pablum.” I agree that some of the outrage over compensation by TARP recipients is a bit overblown. But I also think that the incentives created by current compensation structures were a serious contributor to the financial crisis – which was, after all, largely about banks taking one-sided risks because of asymmetric payouts (lots of upside, limited downside) – and that fixing those incentives is an important task for regulatory reform.

So, I decided to call on some reinforcements. Lucian Bebchuk, a leading researcher of executive compensation (book; importat paper discussed here), and Holger Spamann have a new paper called “Regulating Bankers’ Pay” that discusses precisely this issue. They conclude not only that regulation of banks’ executive compensation would be a good thing, but that it may actually be better than the traditional regulation of banks’ activities.

Continue reading “More on Executive Compensation” →

Does the Administration Care About Executive Compensation?

They certainly want you to think they do. Yesterday was Executive Compensation Day in Washington. The Treasury Department appointed Kenneth Feinberg to oversee executive pay at seven companies that have received extensive government aid – AIG, Citigroup, Bank of America, and the car companies and their finance companies. The administration, which always seemed uneasy with the popular outrage over bonuses earlier this year, seems willing to throw the seven sinners to the wolves, while letting the bulk of the financial sector off the hook. Feinberg will only provide advice to other TARP beneficiaries, and banks that pay back TARP money will not even have to deal with that.

This, of course, solves precisely nothing. The problem with “executive compensation” – no, make that just “compensation” – in the financial sector was its structure. Huge end-of-year bonuses tied to short-term metrics, with no corresponding downside risk, motivated people to take on excessive risk in hopes of maximizing those bonuses. And the companies we need to worry about most are not the ones that are most beaten-down today, but the ones that are (relatively) the strongest and will be taking the biggest bets.

Continue reading “Does the Administration Care About Executive Compensation?” →

The G8 Meeting This Weekend (A Viewer’s Guide)

If you’d like to attend the G8 Ministers of Finance meeting this weekend, the Italian Ministry of Finance has put out a handy travel guide.

Alternatively, take a look at my preview on The New Republic’s website. Our leadership appears to be resting on its laurels after the April G20 summit – or perhaps they think the next G20 summit in September is the place for real discussion. Regulatory reform still needs (a) to happen in a meaningful sense for the financial sectors in all industrial countries, and (b) to be closely coordinated across countries – if your bank is too big to fail in my country, whose problem is that and whose taxpayers are on the hook? But gone completely from the G7/G8 ministerial level is any sense of urgency; all we’ll hear is self-congratulation.

And in terms of macroeconomic policy, discussed in a piece with Peter Boone on the NYT’s Economix this morning, current global early warning signs (higher oil and other commodity prices; rising long-term yields) are being interpreted by policymakers as indicators of success and return to “normalcy”. It reminds me of official discussions in early 2007 – no matter what weakness you could point out in US housing and European banking, leading G7 policymakers were completely in denial, with articulate arguments about why they were right.

Incrementalism is the preferred policymaking culture of G7 ministries of finance and central banks, and they are very much back in that mode. But if you put incrementalism together with refusing to really change the rules for banks and huge, unconditional support for credit that is hard to withdraw, what do you get?

By Simon Johnson

Innovation, Regulation, and Credit Cards

Fresh Air had an excellent interview with Georgetown law professor Adam Levitin, who blogs here. It’s only 21 minutes and I recommend it if you are interested in credit cards or in financial regulation in general.

Credit cards are an interesting if perhaps extreme case of the interplay between “innovation” and regulation in the financial industry. A long time ago, someone invented the credit card. This was a real, beneficial innovation, because it allowed people to make medium-sized purchases on credit. (You could already buy a house on credit, if you put 30% down.) Let’s say that without credit, it would take you nine months to save enough money to buy a refrigerator. Now you could buy the refrigerator and then save the money; it might take you ten months with the interest, but you get to use the refrigerator for that whole time. (A refrigerator could also save you money, because it might allow you to go shopping less often, buy in bulk, and eat at home more.) All good so far.

Continue reading “Innovation, Regulation, and Credit Cards” →

Posner, Part II: What Now?

Note: After writing this, I read Brad DeLong’s better review of Posner’s book (hat tip Felix Salmon). I won’t be offended if you go read that instead.

Part I of my comments on Richard Posner’s epic blog discussed the concept of blame. Today I am going to discuss his approach to some policy questions.

Posner’s crisis book is boldly titled “A Failure of Capitalism.” The problem is that when the lens through which you see the world is capitalism – or, more precisely, a flavor of economics that works out to justify capitalism in virtually every instance – it’s not clear what’s left over when capitalism fails.

Posner’s method is simple, and I can do it, too. Basically, for any policy, extrapolate out its effect until you can demonstrate that it will lead to a bad (and preferably non-intuitive) outcome – typically by changing the incentives for rational actors so that they no longer maximize profits and thereby social utility. When you do this enough, it becomes such second nature that you forget to spell out your arguments. Here’s a simple example:

While cramdown would have benefited some homeowners, it would have hurt lenders and thus have undermined the bank bailouts.

That’s the whole argument. Filling in the blanks, Posner is saying that because you have decided (a) to bail out banks, you cannot undertake another policy (b) – which may have its own costs and benefits – because it is in some way contrary to policy (a).

Continue reading “Posner, Part II: What Now?” →

“There Were Ratings That We Saw That Made No Sense To Us.”

This American Life had another good financial crisis episode by the Planet Money team this past weekend. There’s a story on regulatory holes by Chana Joffe-Walt and one on rating agencies by Alex Blumberg and David Kestenbaum. The latter had some money quotes (starting around the 40-minute mark).

Jim Finkel, Dynamic Credit, which creates structured products: “There were ratings that we saw that made no sense to us. We knew the rating agency models and metrics, and we could replicate them ourselves, and we couldn’t make sense of what they were doing.”

Felicia Grumet (sp?), Bear Stearns, who was involved in creating structured products: “It makes me feel really bad, so actually it’s very hard for me to acknowledge . . . I knew what I was doing. I knew I was doing things to get around the rules. I wasn’t proud of it, but I did it anyway.”

One of the heroes is Mabel Yu, a buy-side bond analyst at Vanguard, who couldn’t get the rating agencies to explain the ratings they were giving to structured products – and therefore refused to recommend them internally at Vanguard. Who knew? Not only do you get lower costs at Vanguard, but better fund management, too? (I have most of my money at Vanguard, but it’s in all in index funds or near-index funds, so I guess I wasn’t benefiting from Yu’s research.)

By James Kwak

Small Bank Big Trouble?

One of the more interesting counter-arguments against the idea that big banks should be broken up comes from people who play close attention to the behavior of small banks. They point out that small banks are a powerful political lobby, a point nicely illustrated by the NYT’s explanation of how changes to bankruptcy law were recently derailed.

The big banks, in this view, are no more oligarchic in their tendencies than small banks.

It is definitely the case that small banks can get together and demand political favors. You need transparency and a strong open debate to offset that – and, according to leading congressional figures, you also need the Obama administration to show up, help out, and resist capture: Continue reading “Small Bank Big Trouble?” →

Annoying Bank Propaganda

JPMorgan Chase has a “community support” page entitled “The Way Forward.” It features a report by JPMorgan executive Michael Cembalest on the credit crisis called “The Big Dig,” which tries to argue that bank lending has actually increased during the credit crisis. Many more accomplished people than I have debunked this myth in the past, but I couldn’t let this pass.

Here’s the main claim: “Changes in credit are often thought to have been wrought by banks. But a simple exercise in forensics reveals that not to be the case: the rise and fall of securitized loan markets have a much larger impact. Bank lending has remained stable throughout, while securitized markets collapsed.”

Changes

in credit are often thought to have been

wrought by banks. But a simple exercise in

forensics reveals that not to be the case: the rise

and fall of securitized loan markets have a much

larger impact. Bank lending has remained stable

throughout, while securitized markets collapsed.

And here’s the evidence:

Continue reading “Annoying Bank Propaganda” →

The State and Local Hole

Although you may pay more taxes to the federal government, there is a good chance that the public services you are more likely to actually encounter in your life are provided by state or local governments – schools, swimming pools, police, fire, etc. While a lot of attention has focused on the federal government’s deficit problems, the problem for state and local governments, which generally have less fiscal flexibility (and cannot print money) is at least equally serious.

Here is the projected aggregate state/local government budget gap under two scenarios. First the “low gap” (optimistic) picture:

Continue reading “The State and Local Hole” →

Global Crisis And Reform: Starting A Long Journey

I spoke Friday afternoon to MIT Sloan graduates (Reunion Weekend; slides attached), arguing that while we are likely done with a panic or “free fall” phase, we have only just begun to deal with the deeper problems revealed by the global financial crisis.

Think of it this way. The United States has done well over the past 200 years or so because it was founded with strong institutions – rules and laws that mean we’re protected against government or powerful elites becoming too powerful – and over time these have generally improved, or at least not collapsed under pressure. Yes, you can complain about (and aim to improve) many aspects of our society, but where would you prefer to set up a technology-based business or make any kind of productive investment or build your own human capital?

Call this the rule of law, or protection against being expropriated, or sufficient constraints on executive power, but it adds up to roughly the same thing. We strongly limited the power of the most powerful in our society – and this is in striking contrast to what happens in much of the rest of the world.

But over the past 20-30 years, we took our eye off this ball. Continue reading “Global Crisis And Reform: Starting A Long Journey” →

The Problem with Opinion Polls

Back in December, when people actually had debates about whether or not Chrysler and GM would go bankrupt, one of the claims made by the anti-bankruptcy camp was that 80% of people would not buy a car from a bankrupt automaker. That number came from a CNW survey; here’s a summary from Motor Trend (hat tip Jane Hamsher):

A recent study from automotive market research firm CNW surveyed 6000 people intending to buy a new car within six months, and discovered that more than 80 percent of them would switch brands if the vehicle they wanted came from an automaker that went bankrupt. Breaking it down by company, Americans were more likely to abandon domestic automakers than foreign ones, with Chrysler faring the worst — a full 91 percent of buyers wouldn’t take home an Auburn Hills product if the company went bankrupt.

The theory was that bankruptcy would lead to an immediate collapse in sales which would lead to liquidation. (A later study, cited here, said that if the government were involved in the bankruptcy, the number of people who wouldn’t consider buying from GM would be 51%.)

This is what I said in December:

I strongly suspect that 80% is just a poorly worded and interpreted poll question. If you ask people in the abstract if they would buy cars from a bankrupt car company, of course they will say no. But in the real world, if the car they want is made by a bankrupt company, and they get a good deal, they will buy it. Just look at the November auto sales. GM was down 41%; Toyota, Honda, and Nissan were down 34%, 32%, and 42%, respectively. And everyone buying a car in November must have been aware that bankruptcy for GM was a serious possibility. (Besides, haven’t we been talking about a GM bankruptcy on and off for years?) Sure, bankruptcy will hurt sales a little. But 80% is just not credible.

Well, now we know. In May – during which Chrysler was in bankruptcy – Chrysler sales were down 47% from the year-ago period. Overall sales were down 34%, which means non-Chrysler sales were down around 33%. So as a crude estimate, if Chrysler were like the average automaker, for every 100 cars it sold last May, it would have sold 67 cars this May. Instead, it sold 53. That’s a 21% decrease – a lot less than the 91% predicted.

I’m not claiming I can predict auto sales better than other people – I know virtually nothing about auto sales. I’m just saying you shouldn’t rely on polls that ask people what they would do under some hypothetical scenario, since they don’t know what they would do.

By James Kwak

The Economics of RSS

I rarely write about blogging itself – I take it for granted – but Felix Salmon, one of the real proponents of the medium, has a new post on RSS feeds and why they matter. First you should read his original post,* which argues that information providers (such as blogs) should provide full RSS feeds (including the full content of the article), like we do here, rather than truncated feeds (showing just the first few lines), which most but not all ad-supported web sites do. His argument is that the success of a blog depends on getting other bloggers and journalists to link to it, and those bloggers and journalists are far more likely to read your blog if you publish a full RSS feed. I believe his argument, but as he says in the new post, it would be nice to see some empirical research to know if we are wrong.

Like Felix, I read blogs through my RSS reader – Google Reader – and I basically never click through to read the full post if all I get is a truncated feed. So if a blog doesn’t publish a full feed, I am only likely to read a post if it is recommended or excerpted in a blog that does, such as Calculated Risk, Economist’s View, Marginal Revolution, etc. (I do scan a few online newspapers the old-fashioned way – on their web sites.)

Of course, I’m just one blogger, and if the really big guys like Paul Krugman and Andrew Sullivan are happy with truncated feeds, then Felix and I could be wrong. If anyone knows of any empirical research out there, please let us know.

* Yes, that post is by Felix, not by Ryan Avent, who replaced him at Portfolio earlier this year. In an impressive display of technical incompetence, Portfolio has not figured out how to show that some posts have one author and other posts have another offer. I know that they are going through hard times, but this can’t be that difficult.

By James Kwak

The Little Pension Funds That Could?

Those following the Chrysler bankruptcy know that the final holdouts are a set of Indiana pension funds, who have appealed the bankruptcy judge’s approval of the restructuring plan, attempting to force the company to explore other alternatives under a trustee who is independent of the government. They were lustily cheered on by The Wall Street Journal, elated to find good sturdy workingmen and -women willing to stand up to the Obama Administration and its “disdain for legal contracts,” and who could not be dismissed as speculators.

Well.

The pension funds in question bought the Chrysler debt in question last July for 43 cents on the dollar. (They stand to get 29 cents on the dollar in the restructuring.) I guess the difference between that and speculation is that “speculation” is something that bad people do; when pension funds by distressed debt, it’s called “investment.” I have no problem with pension funds buying modest amounts of risky investments, but they are taking the same risks that hedge funds are taking, and if they lose money on bad investments, that’s the fault of the pension fund managers.

Continue reading “The Little Pension Funds That Could?” →