By James Kwak

“Fed Tells Big Banks to Shrink or Else,” the Wall Street Journal proclaimed in the headline of its lead story today.* If only.

What the Federal Reserve actually did is impose new, additional capital requirements for the largest banks. JPMorgan Chase, for example, will have to hold 4.5 percentage points more capital than it would have had to otherwise. This is clearly a good thing, since it means that the banks that could do the most damage to the financial system will be a little bit safer. But it is neither a complete solution, nor is it the draconian constraint that the banks and the Journal make it out to be.

For starters, the rule will have no effect on seven of the eight banks in question (JPMorgan is the exception), since they already have enough capital to meet the new requirements. That alone should let you know how significant a rule this is.

Continue reading “More Misinformation about Banking Regulation” →

By James Kwak

“We shall again take for granted the availability of a system of public relief which provides a uniform minimum for all instances of proved need, so that no member of the community need be in want of food or shelter.”

That’s from The Constitution of Liberty, “definitive edition,” p. 424. Yes, it comes as part of Hayek’s argument against mandatory state unemployment insurance. But it reflects a fundamental understanding that no one should go without food or shelter, and that it is the duty of the government to ensure this minimum level of existence. “The necessity of some such arrangement in an industrial society is unquestioned,” he wrote (p. 405).

The standard that Hayek simply assumed would exist goes beyond merely keeping poor people alive. In a wealthy society, he thought it inevitable that it would become “the recognized duty of the public to provide for the extreme needs of old age, unemployment, sickness, etc.” (p. 406). On this basis, he even endorsed the idea of compulsory insurance, such as the individual mandate of the Affordable Care Act.

I’m not claiming that Hayek would have supported Obamacare — he almost certainly would have favored less government involvement than the system of state-level exchanges. But on the questions of welfare and government intervention in insurance markets, he was to the left of the entire Republican Party today.

[Also posted on Medium.]

By James Kwak

In Capitalism and Freedom, Milton Friedman asks what types of inequality are ethically justifiable. In particular (pp. 164–66):

“Inequality resulting from differences in personal capacities, or from differences in wealth accumulated by the individual in question, are considered appropriate, or at least not so clearly inappropriate as differences resulting from inherited wealth.

“This distinction is untenable. Is there any greater ethical justification for the high returns to the individual who inherits from his parents a peculiar voice for which there is a great demand than for the high returns to the individual who inherits property? …

“Most differences of status or position or wealth can be regarded as the product of chance at a far enough remove. The man who is hard working and thrifty is to be regarded as ‘deserving’; yet these qualities owe much to the genes he was fortunate (or fortunate?) enough to inherit.”

I think Friedman is correct here. This is basically the same point that I made in my earlier post: the money that you make because you are smart and hard working is the product of good fortune just as much as the money that you inherit directly from your parents.

Read more at Medium.

By James Kwak

Mark Buchanan — who is actually a physicist, after all — makes a compelling argument against relying on geo-engineering to deal with our climate change problem. For one thing, some of the proposed technologies simply won’t work, because they do nothing about the fact that the poles are warming faster than the rest of the planet. For another, the geo-engineering fairy is being used to lobby against other approaches — conservation and renewable energy sources — that would deal with climate change at its source.

Another reason to be skeptical of geo-engineering is the effect it has on the risk profile of humanity’s future. Technology has produced some amazing things in the past century. But, with zero exceptions that I can think of, they weren’t things that our species needed to survive, or to prevent widespread natural and societal devastation. If we’re talking about technologies that can make our lives better in all sorts of ways, like the Internet or DNA sequencing or quantum computing, then risk is good: we want to place lots of bets that have a high chance of failure but high potential returns.

Read more at Medium.

By James Kwak

One of the central dramas of the early seasons of The Wire is the cat-and-mouse game between Avon Barksdale’s drug operation and the detectives of the Major Crimes Unit. The drug dealers started off using pagers and pay phones. When the police tapped the pagers and the phones, Barksdale’s people switched to “burner” cell phones that they threw away before the police could tap them. By Season 4, Proposition Joe advised Marlo Stanfield not to use phones at all.

Well, apparently, Wall Street currency traders don’t watch The Wire. I don’t think anyone was surprised to learn that major banks including JPMorgan, Citigroup, Barclays, RBS, and UBS conspired to manipulate currency prices — something that regulators have been investigating for over a year and a half. One common strategy was cooperating to time large transactions in order to manipulate daily benchmark rates at which other client transactions are executed.

Read more at Medium.

By James Kwak

“In my many years of experience working in compliance, do you know how many fixed and variable annuities I’ve seen being invested in IRAs??? Countless.

“Investing a tax deferred investment within a tax deferred account simply does not make sense, except for very very few exceptions. … And when brokers answered me honestly as to why they picked annuities over mutual funds or even plain vanilla stocks??? Payout baby!!!”

That’s a compliance officer at Wells Fargo talking about the kinds of abuses that brokers — who advise clients about where to put their money, even if they aren’t “registered investment advisers” — inflict on their customers. For context: The benefit of an annuity is that taxes on earnings are deferred until withdrawals — but you get that benefit in any IRA, so there’s no point in putting an annuity (which has higher costs than an ordinary mutual fund) in an IRA. Yet in this case the brokers were pushing annuities because of the (legal) kickbacks they were getting from the annuity providers.

Read more at Medium.

By James Kwak

“At present, when zero interest rates make capital costs as low as they have ever been but corporate profits are at record levels, there needs to be much less concern with capital costs and more concern with the distributional aspects of capital taxation.”

That’s Larry Summers — with whom I have often disagreed in the past — at a Brookings event on the tradeoff between equality and efficiency. For most of our lives, government policy in the United States and most of the developed world has been focused (at least in theory) on efficiency: colloquially speaking, making the pie bigger rather than worrying about how the pie is divided up. Rising tide, boats, you know the rest: Laffer Curve, unleashing the job creators, and so on. Inequality is something we profess to regret while doing nothing about it.

Read more at Medium.

By James Kwak

Unemployment is down to 5.4%! Yay!

That was the summary of last week’s unemployment report. Yet the two-track “recovery” — about to enter its seventh year — continues. Average hourly wages increased by only 0.1% in April and 2.2% for the past twelve months, which amounts to basically nothing when you take inflation into account.

This is what the new normal looks like. Wages barely rise during periods of economic “expansion” (you know, the opposite of recession), then fall when unemployment spikes during a recession. In the long run, that means that average real earnings actually go down, and household income can only keep up if people work more hours. Yet the number of full-time jobs is lower today than it was before the financial crisis.

Read more at Medium.

By James Kwak

I’ve written several times about what I call the Economics 101 ideology: the overuse of a few simplified concepts from an introductory course to make sweeping policy recommendations (while branding any opponents as ignorant simpletons). The most common way that first-year economics is misused in the public sphere is ignoring assumptions. For example, most arguments for financial deregulation are ultimately based on the idea that transactions between rational actors with perfect information are always good for both sides — and most of the people making those arguments have forgotten that people are not rational and do not have perfect information.

Mark Buchanan and Noah Smith have both called out Greg Mankiw for a different and more pernicious way of misusing first-year economics: simply ignoring what it teaches — or, in this case, what Mankiw himself teaches. At issue is Mankiw’s Times column claiming that all economists agree on the overall benefits of free trade, so everyone should be in favor of the Trans-Pacific Partnership, among other trade agreements.

Read more at Medium.

By James Kwak

The neolithic political ideology of Thomas and Friends is so overbearing and obvious that it’s not worth writing about (except in parody, which I won’t attempt here). Duncan Weldon has taken up the more interesting question of what Thomas, Percy, and their friends can tell us about the economy of Sodor, that strange island trapped somewhere off the coast of Great Britain and in a weird time warp that vaguely resembles the mid-twentieth century.

Like Duncan, I have watched plenty of Thomas videos, in my case in the company of my three-year-old son Henry. One thing that has often struck me about Sodor Railways is the vast amount of excess capacity. The most common plotline goes like this: Some engine has a job to do. However, said engine chooses to do something else out of vanity, unwillingness to go out in bad weather, curiosity, or something similar. Late in the episode, either the engine realizes the error of his ways and does his job, or some other engine does it for him. In either case, the original engine learns his lesson: that it is best to be Really Useful and not to cause Confusion and Delay. (Only, he never really learns the lesson — see the next episode.)

Read more at Medium.

By James Kwak

Is it the money?

No.

Federal Reserve Chair Ben Bernanke, the man who saved the global economy, is becoming an adviser for Citadel, a hedge fund management company. Bernanke will provide advice to Citadel’s fund managers and will also meet with its clients (that is, the limited partners who invest in those funds).

It’s easy to see why Citadel wants Bernanke. He’s a smart man. He knows the inner workings of the world’s central banks as well as anyone. Although he won’t be a registered lobbyist, he can pick up the phone and get anyone in the world to answer, if he wants to. And, perhaps most importantly for the bottom line, the wow factor of having Bernanke meet with investors will help immeasurably with sales — bringing investments in the door.

The bigger question, as always, is why Bernanke wants Citadel.

Read more at Medium.

By James Kwak

Beeping iPads! Buzzing phones! Zapping watches! Soon, apparently, we won’t be able to complete a thought without being interrupted by some “intelligent” piece of technology.

The solution, according to Steven Levy, is yet more technology:

a great artificial intelligence effort to comb through our information, assess the urgency and relevance, and use a deep knowledge of who we are and what we think is important to deliver the right notifications at the right time. . . .

the automated intake of our information will allow us to “know by wire,” as super-smart systems learn how to parcel things out in the least annoying and most useful fashion. They will curate better than any human can.

First of all, I’m skeptical. So is Levy, apparently; just a few paragraphs up, he writes, “the idea of One Feed to Rule Them All is ultimately a pipe dream.” The same factors that make it impossible for one company to create a perfectly prioritized feed make it impossible for one company to create a perfectly prioritized stream of notifications.

Read more at Medium …

By James Kwak

Dan Davies put together a brilliant roundup of the clever business models that financial technology startups are pitching to their investors — and why most of them are deeply flawed. Some of them apply much more broadly than to just the financial services industry. Number three, for example — “Hoping that a load of people who actively mistrust each other will trust you instead” — is a decent description of the business-to-business marketplaces that Ariba was trying to build when I worked there back at the beginning of the millennium.

I’d like to add two more general principles that apply to technology companies that are trying to serve the financial services industry — mainly learned during my years working at an insurance software company before going to law school.

Read more on Medium …

(I’m going to try switching to a Brad DeLong-style approach in which I put the beginnings of my Medium posts here, and then you can decide if you want to read more or not. I can’t put the whole post here because they have thirty-day exclusivity.)

By James Kwak

Did you know that blogging is dead? That’s what I hear, anyway. I plan to say something about it once I figure out if I have anything to say on it.

Anyway, as you have probably noticed, I do most of my sporadic writing over at Medium these days. Since I last checked in here, I wrote stories about:

• Why I crippled my smartphone;
• The misleading campaign against the estate tax; and
• The fallacy on the first page of Gregory Mankiw’s textbook

I also posted an essay by Walt Glazer about inequality.

You can see all of my Medium stories here, or you can read the whole Bull Market publication (now including Brad DeLong!).