Month: November 2009

Auto Race to the Bottom

This guest post was contributed by Raj Date, head of the Cambridge Winter Center for Financial Institutions Policy and a former McKinsey consultant, bank senior executive, and Wall Street managing director. For further information on the auto dealer exemption, see the recent study by the Cambridge Winter Center.

Over the past several months, Congress has debated ways to strengthen and rationalize consumer protection in financial services.  Central to that debate is the proposed creation of a new agency focused exclusively on this issue, the Consumer Financial Protection Agency (the “CFPA”).

Even among proponents, however, there are varying conceptions of the scope and function of the CFPA.  For example, the CFPA as envisioned by the House Financial Services Committee would exclude auto dealers from the CFPA’s coverage.  The Administration’s original proposal would have included them.  Starting this week, the Senate Banking Committee will have to wrestle with the same question.

They shouldn’t have to wrestle long:  Even by the low analytical standards applied to hastily arranged, crisis-driven corporate welfare initiatives, the exemption of auto dealers from the CFPA appears profoundly ill conceived.  Exempting auto dealers would simultaneously be bad for consumers, bad for industry stability, and bad for what remaining sense of free-market integrity we still have.

Continue reading “Auto Race to the Bottom” →

What Did TARP Do?

This morning, starting at 9:30am, the Congressional Oversight Panel holds a hearing to assess the performance of the Troubled Asset Relief Program (TARP).  The hearing will be streamed live and also archived, featuring testimony from: Dean Baker (Center for Economic and Policy Research), Charles Calomiris (Columbia University), Alex Pollock (American Enterprise Institute), Mark Zandi (Moody’s Economy.com), and me.

In late September 2008, Secretary of the Treasury Henry S. Paulson asked Congress for $700 billion to buy toxic assets from banks, as well as unconditional authority and freedom from judicial review. Many economists and commentators suspected that the purpose was to overpay for those assets and thereby take the problem off the banks’ hands – indeed, that is the only way that buying toxic assets would have helped anything. Perhaps because there was no way to make such a blatant subsidy politically acceptable, that approach was shelved. Continue reading “What Did TARP Do?” →

Slow Cat, Fast Mouse

One of our readers pointed me to a paper by Edward Kane with the unfortunately complicated title “Extracting Nontransparent Safety Net Subsidies by Strategically Expanding and Contracting a Financial Institution’s Accounting Balance Sheet.” The paper is an extended discussion of regulatory arbitrage — not the specific techniques (such as securitization with various kinds of recourse) that banks use to finesse capital requirements, but the larger game played by banks and their regulators. This is how Kane frames the situation:

“Regulation is best understood as a dynamic game of action and response, in which either regulators or regulatees may make a move at any time.  In this game, regulatees tend to make more moves than regulators do.  Moreover, regulatee moves tend to be faster and less predictable, and to have less-transparent consequences than those that regulators make.

“Thirty years ago, regulatory arbitrage focused on circumventing restrictions on deposit interest rates; bank locations; charter powers; and deposit institutions’ ability to shift risk onto the safety net.  Probably because regulatory burdens in the first three areas have largely disappeared, the fourth has become more important than ever.  Today, loophole mining by financial organizations of all types focuses on using financial-engineering techniques to exploit defects in government and counterparty supervision.”

Continue reading “Slow Cat, Fast Mouse” →

Time For Coordinated Capital Account Controls?

This guest post was submitted by Arvind Subramanian, a senior fellow at the Peterson Institute for International Economics.  Arvind is a leading proponent of the view that we need to rethink capital controls – he sees them as central to meaningful macroprudential regulation going forward.  (He also has an op ed in today’s Financial Times, on climate change, economic development, and the basis for an international agreement.)

The Bretton Woods Committee is organizing a panel (today, Wednesday) on the role of the G-20 in coordinating global growth with speakers from the IMF, US Treasury, and the G-24 group of developing countries.  “Global imbalances” (the US current account deficit, the Chinese current account surplus, etc) will be discussed extensively. But I will also raise the question of whether there is a new imbalance in the world economy that threatens emerging markets, and what they should do about it.

Extraordinarily loose monetary policy and the resulting close-to-zero interest rates in many industrial countries are pushing capital out to emerging markets—Brazil, China, and India—whose growth prospects are buoyant and relatively unaffected by the crisis. Brazil’s currency has appreciated by 30 percent this year, India’s stock market soared by 70 percent, and China is once again furiously accumulating foreign exchange reserves, $62 billion in September. Continue reading “Time For Coordinated Capital Account Controls?” →

Banking In A State

“Banking on the State” by Andrew Haldane and Piergiorgio Alessandri is making waves in official circles.  Haldane, Executive Director for Financial Stability at the Bank of England, is widely regarded as both a technical expert and as someone who can communicate his points effectively to policymakers.  He is obviously closely in line – although not in complete agreement – with the thinking of Mervyn King, governor of the Bank of England.

Haldane and Alessandri offer a tough, perhaps bleak assessment.  Our boom-bust-bailout cycle is, in their view, a “doom loop”.  Banks have an incentive to take excessive risk and every time they and their creditors are bailed out, we create the conditions for the next crisis.

Any banker who denies this is the case lacks self-awareness or any sense of history, or perhaps just wants to do it again. Continue reading “Banking In A State” →

Steve Randy Waldman on Financial Regulation

I would like to strongly recommend Steve Randy Waldman’s recent post on “Discretion and Financial Regulation.” He begins like this: “An enduring truth about financial regulation is this: Given the discretion to do so, financial regulators will always do the wrong thing.” It gets better from there.

In fact, I’d recommend it over anything I’ve written this morning, so why don’t you head over now.

By James Kwak

Economics Puzzler of the Day

Gretchen Morgenson of The New York Times (hat tip Calculated Risk) reports that the recent Worker, Homeownership and Business Assistance Act of 2009 (which included the expansion of the homebuyer tax credit) included a curious tax break for money-losing companies:

“a tax break that lets big companies offset losses incurred in 2008 and 2009 against profits booked as far back as 2004. The tax cuts will generate corporate refunds or relief worth about $33 billion, according to an administration estimate.

“Before the bill became law, the so-called look-back on losses was limited to small businesses and could be used to counterbalance just two years of profits. Now the profit offset goes back five years, and the law allows big companies to take advantage of it, too.”

Morgenson focuses on the fact that some of the biggest beneficiaries will be the massive home-building companies that raked in huge profits during the height of the boom, and that they have no apparent plans to hire new workers. “After spending its $210,000, Pulte will receive $450 million in refunds. And Hovnanian, after spending its $222,000, will get as much as $275 million.” (If you’re not enraged by the behavior of some of these companies, you should read Chapter Five of Our Lot by Alyssa Katz.)

Continue reading “Economics Puzzler of the Day” →

One Cost of Too Big to Fail

A reader pointed out a quick analysis done by Dean Baker and Travis McArthur of the Center for Economic Policy and Research back in September. They estimate the value of being “too big to fail” by looking at the spread between the cost of funds for banks above $100 billion in assets and banks below that level. The spread averaged 0.29 percentage points from 2000 through 2007, but rose to 0.78 percentage points from Q4 2008 through Q2 2009, an increase of 0.49 percentage points. Alternatively, the spread peaked at 0.69 percentage points from Q4 2001 through Q2 2002 at the end of the last recession; by comparison, the spread this time around was only 0.09 percentage points higher. Using 0.09 and 0.49 percentage points as their low and high estimates, Baker and McArthur come up with an estimate of the aggregate value of being TBTF that ranges from $6.3 billion to $34.2 billion per year.

Continue reading “One Cost of Too Big to Fail” →

Who’s Afraid Of A Falling Dollar?

This guest post was submitted by Joe Gagnon, a senior fellow at the Peterson Institute for International Economics.  Joe is an expert on international economics has spent a great deal of time studying the effects of exchange rate depreciation.  Even if the dollar depreciates sharply in the near term, he argues that is unlikely to have adverse effects – primarily because inflation will stay low.

Pundits and policymakers around the world are wringing their hands over the possibility of further declines in the foreign exchange value of the dollar.  Predicting exchange rates is notoriously difficult; there is almost as much chance of the dollar rising next year as of it declining.  But if the dollar were to fall further, should we be concerned?

A lower dollar is good news for US exporters and foreign importers and bad news for foreign exporters and US importers.  However, if policymakers respond appropriately, there is no reason to fear overall harm either to the US economy or to foreign economies.  Indeed, a lower dollar could jumpstart the long-overdue rebalancing of the global economy away from excessive US trade deficits and foreign reliance on export-led growth, putting the world on track for a more sustainable expansion. Continue reading “Who’s Afraid Of A Falling Dollar?” →

Note to Jamie Dimon: Repeating Something Doesn’t Make It True

Note: I’ve updated this post at the end with another response to Jamie Dimon, this one by James Coffman. Coffman served in the enforcement division of the SEC for over twenty years, most recently as an assistant director of enforcement, and previously wrote a guest post for this blog.

In the Washington Post, Jamie Dimon asserts that we shouldn’t “try to impose artificial limits on the size of U.S. financial institutions.” Why not?

“Scale can create value for shareholders; for consumers, who are beneficiaries of better products, delivered more quickly and at less cost; for the businesses that are our customers; and for the economy as a whole.”

I don’t know of any serious person who believes this to be true for banks above, say, $100 billion in assets. Charles Calomiris, who studies this stuff, couldn’t find anything stronger to back up the economies of scale claim than a study saying that bank total factor productivity grew by 0.4% per year between 1991 and 1997 — a study whose author thinks that the main factor behind increasing productivity was IT investments.

Continue reading “Note to Jamie Dimon: Repeating Something Doesn’t Make It True” →

The Real Choice on Too Big to Fail

Gillian Tett has an article criticizing the idea that CoCos — contingent convertible bonds — will solve the “too big to fail” problem. (And yes, she calls it “too big to fail,” even though Gillian Tett of all people understands what interconnectedness means.)

Contingent convertible bonds, a.k.a. contingent capital, are the latest fad to hit the optimistic technocracy in Washington and London. A contingent convertible bond is a bond that a bank sells during ordinary times, but that converts into equity when things turn bad, with “bad” defined by some trigger conditions, such as capital falling below a predetermined level. In theory, this means that banks can have the best of both worlds. They can go out and borrow more money today, increasing leverage and profits (which is what they want). But when the crisis hits, the debt will convert into equity; that will dilute existing shareholders, but more importantly it means the debt does not have to be paid back, providing an instant boost to the bank’s capital cushion. In other words, banks can have the additional safety margin as if they had raised more equity today, but without having to raise the equity.

Continue reading “The Real Choice on Too Big to Fail” →

How Well Prepared Are Americans for Retirement?

The following guest post was contributed by Andrew Biggs. He has studied the issue of retirement savings for a couple of orders of magnitude longer than I, so I wanted to give him the opportunity to outline his perspective on the topic. He regularly blogs on his own blog and, along with about four dozen other people, over here.

After our exchange regarding Tuesday’s blog on The Retirement Problem in the Washington Post (which started over at AEI’s Enterprise blog and continued here),  James generously offered to let me guest-post my thoughts on Americans’ level of preparation for retirement. Overall I’m not so pessimistic, although there are surely problems that must be addressed. But most of the detailed research out there points to problems, but not a crisis.

Both James’s analysis and my own response were built on relatively simple projections using stylized workers who pay into Social Security and participate in 401(k) plans. These illustrations are useful for fleshing out basic issues – plus, in this case, finding how the SSA’s online benefit calculator may have skewed some of the results.

But the best research on retirement preparedness is more involved than this. Most analysis of current retirees uses survey data, such as from the Health and Retirement Study (HRS), the Survey of Income and Program Participation (SIPP), the Fed’s Survey of Consumer Finances (SCF) and the Current Population Survey (CPS). Each survey has strengths and weaknesses.

In addition, broader models of the population are built using this survey data. These models allow for simulations of how policy changes affect current retirees, as well as projecting the population into the future. Such comprehensive models include the Social Security Administration/Urban Institute MINT (Modeling Income in the Near Term) model, the Congressional Budget Office’s CBOLT (CBO Long Term) and the Policy Simulation Group’s PSG suite of models, used by the Government Accountability Office and the Department of Labor for Social Security and private pension projections. While these models, like any others, rely on assumptions regarding a large number of factors, they are also the most closely scrutinized to ensure these assumptions are consistent with current trends.

Continue reading “How Well Prepared Are Americans for Retirement?” →

Ask Sheila Bair

A producer at the Lehrer NewsHour just sent me this email:

“Just thought I’d alert you to something we’re advertising today on Paul’s blog, The Business Desk. Paul [Solman] is interviewing the FDIC’s Sheila Bair tomorrow, and she’s agreed to answer several questions from NewsHour viewers, which we’ll post in a special video.

I thought your readers might have some excellent suggestions.”

Follow the link embedded above to post questions.

By Simon Johnson

Dollar Doom Loop

The American dollar is in the midst of a large fall in its value, or depreciation, as measured against other major currencies. The decline has been steady since 2002 and our currency is down about 35 percent from that peak. After strengthening slightly more than 10 percent during the global financial crisis of the past 18 months, the dollar is again falling back toward its pre-crisis lows, representing its weakest international value since 1967.

But there is a definite possibility that the dollar could soon decline further or faster.

At the level of general economic strategy, the American government has responded to a financial sector crisis with an expansionary fiscal policy, and the Federal Reserve is implementing loose monetary policy. Andrew Haldane, responsible for financial stability at the Bank of England, puts it this way:

“For the authorities, [excessive risk-taking by the financial sector] poses a dilemma. Ex-ante, they may well say “never again.” But the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop.” (link to the paper) Continue reading “Dollar Doom Loop” →