Month: March 2010

Banks Paying Customers to Take Overdraft Protection

By James Kwak

I saw a bank ad in the subway yesterday. Basically, it said:

  1. If you set up direct deposit the bank will give you $100.
  2. If you set up overdraft protection the bank will give you $25.
  3. If you activate online bill pay the bank will give you $25.

1 makes sense because (a) it gives the bank more cheap deposits, which are its raw material and (b) it increases your switching costs. 3 makes sense because it increases your switching costs; it may also cause you to give the bank more cheap deposits, since you need money in the account to cover your bills.

2 makes sense because . . . the bank expects to get more than $25 in fees out of the average customer. A single overdraft fee typically costs more than $25. Now people will be making an explicit decision: “I want the $25 now because I don’t think I’ll ever pay an overdraft fee.” (To be fair, they might be thinking, “I already value overdraft protection at $35 per occurrence, so the $25 is just a bonus.” But I doubt many people think overdraft protection is worth $35 per transaction when the typical transaction is a lot less than $35.

There’s nothing illegal about this, and arguably it’s a smart business decision. It just makes things perfectly clear: the banks want those fees so much they are willing to pay you for them.

It’s Not That Easy

By James Kwak

Elizabeth Green (hat tip Ezra Klein) discusses the importance of teaching techniques. Here’s one key passage (at least for people like me):

“The testing mandates in No Child Left Behind had generated a sea of data, and researchers were now able to parse student achievement in ways they never had before. A new generation of economists devised statistical methods to measure the ‘value added’ to a student’s performance by almost every factor imaginable: class size versus per-pupil funding versus curriculum. When researchers ran the numbers in dozens of different studies, every factor under a school’s control produced just a tiny impact, except for one: which teacher the student had been assigned to.”

Continue reading “It’s Not That Easy” →

Way Too Big To Save

By Simon Johnson

Listening to US officials, talking to legal experts, and waiting for an intense Senate debate on financial reform to begin, you can easily form the impression that “too big to fail” adequately describes our most serious future systemic banking problems.  It does not.

In September 2008, the large banks and quasi-banks at the heart of our financial system faced failure – and they were saved in the most immediate sense through actions taken by the Federal Reserve, but TARP (passed by Congress and run Treasury) also played a significant supporting role. 

The Bush administration threw a small fiscal stimulus into the mix in early 2008, hoping to stave off recession; the Obama administration committed a much larger package at the start of 2009, aiming to prevent anything like a Second Great Depression.  This fiscal policy response was in direct reaction to problems caused by the overextension and near failure of the financial system

Do not make the mistake – for example of Secretary Geithner, talking to the New Yorker – of thinking (or implying) that “saving the financial system” did not involve spending a lot of taxpayer money to support the real economy.  Remember that if the economy crashes, asset prices fall, and banks’ problems become even more severe.

And try to avoid three further mistakes that are currently common. Continue reading “Way Too Big To Save” →

They Saved the Big Banks But Kind Of Lost The Economy Doing It

 By Simon Johnson

It would be easy to take relatively cheap shots at the portrayal of Tim Geithner — “we saved the economy but kind of lost the public doing it” — in the New Yorker, out today. 

  1. Mr. Geithner is quoted as saying, “Some on the left have fallen into a trap set by the Republicans, allowing voters to mistakenly think that the biggest part of the bank bailout had come under Obama rather Bush.”  Mr. Geithner should know – as he spearheaded the saving of banks and other financial institutions under both Bush and Obama.  In fact, it’s the continuation of George Bush’s policies by other means that really has erstwhile Obama supporters upset.
  2. “I think there are some in the Democratic Party that think Tim and Larry are too conservative for them and that the President is too receptive to our advice.”  Probably this is linked to the fact that Tim Geithner is not a Democrat.
  3. Geithner also suggests that his critics compare government spending on different kinds of programs under President Obama: “By any measure, the Main Street stuff dwarfs the Wall Street stuff.”  This insults our intelligence.  Wall Street created a massive crisis and we consequently lost 8 million jobs; any responsible government would have tried hard to offset this level of damage with all available means.  This includes fiscal measures that will end up increasing out privately held government debt, as a percent of GDP, by around 40 percentage points.  It’s not the fiscal stimulus, broadly defined, that is Mr. Geithner’s problem – it’s the lack of accountability for the bankers and politicians who got us into this mess.

But the Geithner issues reflected here run much deeper.  The New Yorker’s John Cassidy alludes to these but he may be too subtle.  Here’s the less subtle version. Continue reading “They Saved the Big Banks But Kind Of Lost The Economy Doing It” →

European Monetary Fund, Arriving Soon

By Simon Johnson

American officials are annoyed and deeply skeptical – not thinking that this will amount to anything.  But the future has finally arrived – or perhaps its arrival has just been announced – in the form of the European Monetary Fund.

Such an institution would represent a major reshaping of global financial architecture, undermining the traditional basis of power for the United States – which would prefer to keep the International Monetary Fund (IMF) paramount.  This is a good thing for the world, but also for the IMF and – believe it or not – for the US. Continue reading “European Monetary Fund, Arriving Soon” →

Subsidized Housing

Calculated Risk points out Robert Shiller’s article in the New York Times on the subsidization of homeownership in America. Shiller asks why we should subsidize homeownership, beyond short-term expediencies such as the fact that since we have a lot of unemployed construction workers, we could reduce unemployment by subsidizing homeownership (as long as we can subsidize new home construction as opposed to just trading houses). Of course, the reason we have a lot of unemployed construction workers is that we over-subsidized housing for the past decade and a half; hence Shiller’s question.

Continue reading “Subsidized Housing” →

Current Financial Conditions and Future Economic Activity

By James Kwak

David Leonhardt (hat tip Brad DeLong) discusses the risk of a double-dip recession. For Leonhardt, the main risks are the pending expiration of the fiscal stimulus and some of the Fed’s monetary stimulus measures, as well as continuing de-leveraging by households, which deprives the economy of its usual growth engine.

James Hamilton highlights a new financial conditions index developed by five economists — two from major banks and three from universities. The goal of the index is to estimate the impact of current financial variables on the future trajectory of the economy. For example, the level of current interest rates is likely to influence future economic outcomes. The paper evaluates several existing financial conditions indexes and finds that most of them show financial conditions returning to neutral in late 2009. It then describes a new index comprised of forty-four variables, which tends to do a better job of predicting economic activity than the existing indexes. (The authors admit that this is in part because they have the benefit of living through the recent financial crisis, which has shown the value of certain variables not included in previous indexes.)

So what?

Continue reading “Current Financial Conditions and Future Economic Activity” →

The Deficit Problem Is a Political Problem

By James Kwak

By which I do not mean to say it is not a problem. As Paul Krugman reminds us,

“If bond investors start to lose confidence in a country’s eventual willingness to run even the small primary surpluses needed to service a large debt, they’ll demand higher rates, which requires much larger primary surpluses, and you can go into a death spiral.

“So what determines confidence? The actual level of debt has some influence — but it’s not as if there’s a red line, where you cross 90 or 100 percent of GDP and kablooie . . . Instead, it has a lot to do with the perceived responsibility of the political elite.

“What this means is that if you’re worried about the US fiscal position, you should not be focused on this year’s deficit, let alone the 0.07% of GDP in unemployment benefits Bunning tried to stop. You should, instead, worry about when investors will lose confidence in a country where one party insists both that raising taxes is anathema and that trying to rein in Medicare spending means creating death panels.”

The implication is that our deficits really are a serious problem. But what’s making them a serious problem is not just that they are big and getting bigger; it is that our political system seems incapable of dealing with them. So, ironically, deficit peacocks are right that the deficit is a problem, but only because they refuse to do anything about rising health care costs — since the long-term deficit problem is a health care cost problem.

More Bank Marketing

By James Kwak

I’ve already criticized Citigroup CEO Vikram Pandit’s testimony before the TARP Congressional Oversight Panel on Thursday, but there’s one thing I left out. Citigroup, like other banks not named Goldman Sachs, is attempting to cloak itself in a mantle of goodness. Pandit’s testimony included several bullet points discussing all the wonderful things that Citigroup is doing for ordinary Americans. For example: “In 2009, we provided $439.8 billion of new credit in the U.S., including approximately $80.5 billion in new mortgages and $80.1 billion in new credit card lending.”

Continue reading “More Bank Marketing” →

Uncontrolled Lending to Consumers Spawned the Financial Crisis

This guest post was contributed by Norman I. Silber, a Professor of Law at Hofstra Law School, and Jeff Sovern , a Professor of Law at St. John’s University. They were principal drafters of a statement signed by more than eighty-five professors who teach in fields related to banking and consumer law, supporting H. 3126, which would create an independent Consumer Financial Protection Agency.  Some of the research on which this essay is based is drawn from an article by Professor Sovern.

Did under-regulated lending to consumers play a big part in destabilizing the financial system? Many knowledgeable people say yes, but Professor Todd Zywicki disagrees. (“Complex Loans Didn’t Cause the Financial Crisis,” Wall Street Journal, February 19, 2010).  He claims that the present troubles resulted from the “rational behavior of borrowers and lenders responding to misaligned incentives, not fraud or borrower stupidity.”

Professor Zywicki’s argument enjoys, at least, the modest virtue of technical accuracy, because many objectionable misleading sales practices and agreements that lenders used were, and continue to be, unfortunately, quite legal.  Lending practices may have been regularly misleading and confusing and reckless-but fraudulent?  Well, no, usually not unlawful by the remarkably low standards of the day.   But that in itself is an argument for saying consumer protection laws failed.

Continue reading “Uncontrolled Lending to Consumers Spawned the Financial Crisis” →

Does The Obama Administration Even Want To Win In November?

By Simon Johnson

Increasingly, senior administration officials shrug when you mention the November mid-term elections.  “We did all we could,” and “it’s not our fault” is the line; their point being that if jobs (miraculously at this point) come back quickly, the Democrats have a fighting chance – but not otherwise.

It may be true, at this point, that there is little fiscal policy can do that would have effects fast enough; and monetary policy is out of the administration’s hands.

But ever so quietly, you get the impression the Obama team itself is not so very unhappy – they know the jobs will come back by 2012, they feel that Republican control of the House will just energize the Democratic base, and no one will be able to blame the White House for getting nothing done from 2010 on.

When you push them on this issue, they snap back, “Well, what do you want us to do?  What’s the policy proposal that we are not pursuing?”  But this is exactly the wrong way to think about the issue.

Continue reading “Does The Obama Administration Even Want To Win In November?” →

Toxic Finance

By James Kwak

The first generation of financial crisis books was largely blow-by-blow, behind-the-scenes accounts, like David Wessel’s In Fed We Trust and Andrew Ross Sorkin’s Too Big to Fail — long on characters, events, and dramatic suspense (or at least as much dramatic suspense as you can have when writing about something that unfolded on the front pages of the newspaper), but relatively short on analysis. There were also more analytical books, like Justin Fox’s The Myth of the Rational Market and John Cassidy’s How Markets Fail, which seem like books about free market economics that later turned out to be about the crisis. But one thing this crop had in common is that, for the most part, they ended with the near-collapse of the financial system.

The current generation of books is not just about the crisis and what caused it, but also about the response to the crisis, and what went wrong — that is, why the large banks are bigger, more powerful, and more concentrated than ever before and why the unemployment rate is still languishing around 10%. Joseph Stiglitz’s Freefall (which I haven’t finished reading) falls into this category, focusing more on the governmental responses of 2008-2009 than on the causes of the crisis. So does Yves Smith’s ECONned, which just came out this week. (I have the early version that the publisher sent to Simon a while back.)

Continue reading “Toxic Finance” →

Is Vikram Pandit in Favor of Real Reform?

Testifying today before the TARP Congressional Oversight Panel, Citigroup CEO Vikram Pandit took pains to strike the right notes. Near the beginning of his prepared testimony, he said, “First, however, I want to thank our Government for providing Citi with TARP funds. For Citi, as for many other institutions, this investment built a bridge over the crisis to a sound footing on the other side, and it came from the American people.” Saying “thank you” may not satisfy many people, but it is a step in the right direction.

More importantly, Pandit said that Citigroup is on the side of the angels — in this case, the side of real financial reform:

“Citi supports prudent and effective reform of the financial regulatory system. America – and our trading partners – need smart, common-sense government regulation to reduce the risk of more bank failures, mortgage foreclosures, lost GDP and taxpayer bailouts. Citi embraces effective, efficient and fair regulation as an essential element in continued economic stability.”

When it comes to the substance, though, I’m not sure how much Pandit had to say that was new, although he took care to say it in the nicest way possible.

Continue reading “Is Vikram Pandit in Favor of Real Reform?” →

“No One Made People Buy These Cars . . .”

By James Kwak

The Center for Responsible Lending has a great comic strip titled “If Anti-CFPA Folks Ran Toyota Today?” with classic lines like “Fixing these cars will raise the price of cars in the future, and hurt deserving drivers.” I’m pretty sure it was directly inspired by one of my favorite posts, “If Wall Street Ran the Airlines . . .,” but that’s perfectly fine by me. We have to keep saying the same things over and over because they’re true.

Disastrous Performance By Treasury On Capitol Hill

By Simon Johnson

The campaign to convince people that Treasury is serious about banking reform – led sometimes by President Obama – suffered a major blow today on Capitol Hill.  In testimony to the Congressional Oversight Panel, Assistant Secretary for Financial Stability “and Counselor to the Secretary” Herb Allison said, “There is no too big to fail guarantee on the part of the U.S. government.”

This statement is so extraordinarily at odds with the facts that it takes your breath away. 

Should we laugh at the barefaced misrepresentation of what this administration has done (and the Bush team did) – or just dig out “Too Big To Fail” by Andrew Ross Sorkin and go through all the gruesome details again?  Should we cry for what this implies about Secretary Geithner’s commitment to real reform – if there is no issue with “too big to fail”, then why do you need any new laws that try to address this issue (e.g., such as the Volcker Rules, sent to Congress this week)?

The temptation is to shrug and ignore repeated such insults to our intelligence and implied injury to our pocketbooks.  But this would be a mistake.  Continue reading “Disastrous Performance By Treasury On Capitol Hill” →